This Holiday Surge Isn’t Even the Best Reason to Buy Roku Stock
Streaming device maker Roku (NASDAQ:ROKU) used to be one of Wall Street’s favorite trades. When the company went public at $14 per share in September 2017, there was skepticism regarding the sustainability of the company’s business model in a hyper-competitive streaming device market. But, that skepticism was wiped out by numbers that consistently and significantly topped expectations. Within a year, Roku stock was trading near $80.
But, the stock market rout over the past two months has claimed Roku as one of its biggest victims. Due to renewed fears regarding rising competition, higher rates pressuring the company’s big valuation, and mixed third quarter numbers that implied slowing growth trends, Roku stock has plunged from $80 in the beginning of October, to $40 today.
Right now ROKU looks more like a falling knife than anything else. But, there are reasons to be bullish on this stock ahead of the holiday shopping season and even more reasons to bullish on this name for the next several years.
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As such, while bigger tariffs, rising rates, and stiffer competition create bad optics for this stock, the long-term core fundamentals remain favorable. Once the optics improve, you will get a huge relief rally.
Near-Term Outlook Is Improving
The near term outlook on ROKU has been quite negative ever since the company reported mixed third quarter numbers.
In that report, growth slowed across the board, all-important Platform revenue missed expectations, equally important ARPU also missed expectations, and the fourth quarter profit guide was light.
Thus, despite the ostensible double-beat nature of the report, the Q3 ER was far from perfect. At nearly 10X trailing sales, Roku needed to be perfect to head higher. That didn’t happen, and consequently the stock has fallen off a cliff.
But, the near term outlook is finally starting to improve for this stock. For starter’s, Roku stock dropped into oversold territory, and is now finding its footing around $40. Also, not all was bad about the Q3 report, as account growth and engagement remained robust.
Meanwhile, the valuation today is much more reasonable at around 6.7X trailing sales, which is below where more proven yet slower growth streaming peer Netflix (NASDAQ:NFLX) trades (7.9X trailing sales).
Perhaps most importantly, it appears that Roku is positioned for yet another strong holiday season. Last year the stock rallied more than 20% in December as it became apparent that Roku streaming players were among the hottest holiday gifts in 2017. The same will likely be true again in 2018.
The streaming trend is only growing, and Roku’s market share among streaming players and smart TVs is far higher than where it was last year at the same time. As such, it should be no surprise that Roku devices are yet again a top seller this holiday season, with search interest trends for “Roku” and “Roku TV” spiking to all time highs.
Overall, then, the near-term outlook on Roku stock is much better today than it was two months ago. Today, the stock is much more reasonably valued, has already fallen a bunch, and has strong drivers on the horizon with holiday sales. This combination could ultimately power a rebound in the near-term.
Long-Term Outlook Remains Favorable
Having said all that, you don’t own ROKU because the near-term outlook is good. You own it because this company is supported by very large and very powerful long-term growth drivers. Those growth drivers are the mass proliferation of streaming entertainment services, and the need for consumers to curate those streaming services without bias.
Right now, the streaming market is still in its relative infancy. Granted, Netflix has been around for a while and has over 100 million subscribers. Also, there are over 400 million streaming subscription subscribers in the world. Those are big numbers.
But, they pale in comparison to the number of internet users in the world (4 billion) and the number of TV households globally (1.6 billion).
Inevitably, whether it be Netflix, Amazon (NASDAQ:AMZN), Hulu, DirectTV NOW, Sling, YouTube TV, or some other streaming service, all 1.6 billion global TV households will eventually shift from cable to streaming due to price and convenience advantages.
That means this shift from cable to streaming is only about 25% of the way through. Thus, at scale, Roku should easily be able to quadruple its active account base from 25 million today, to 100 million at scale.
Bears would argue this won’t happen because of competition. But, the competition argument lacks merit because:
Roku is already the market leader with runaway 40% share in streaming players, Roku is also the leader in the smart TV market with 25% share, and Roku is a content agnostic curation platform, making it far more consistent and convenient than streamers from Google (NASDAQ:GOOG) and Apple (NASDAQ:AAPL), which are inherently biased.
Meanwhile, ARPU currently hovers around $17 and is growing at a near 40% clip. Considering Roku is also attacking the $200 billion TV advertising market, ARPU has a healthy runway to head way higher in the long run. During this time, large ARPU increases and a bigger focus on software revenues should drive margins way higher.
Overall, Roku is a company with tremendous account growth, revenue growth, and profit growth potential. Those attributes make this stock a long term winner.
Bottom Line on Roku Stock
Roku stock is a long term winner going through a rough patch. All long term winners go through these rough patches, and they always eventually bounce back.
The same will be true for Roku stock. Timing the recovery is tough. But, with a strong early read on Roku holiday sales, now seems like as good a time as any for this stock to get back on an uptrend.
As of this writing, Luke Lango was long ROKU, NFLX, AMZN, GOOG, and AAPL.
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