Roku (NASDAQ:ROKU) stock surged to all-time highs after the streaming device maker reported quarterly figures that absolutely crushed revenue and profit expectations.
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Specifically, Roku topped revenue estimates by over 20% — growing revenues by a record-high 73% year-over-year — while reporting a sizable profit in the quarter (Wall Street was looking for a pretty wide loss). In response, ROKU stock stormed more than 10% higher.
Zooming out, this blowout earnings report underscores why ROKU stock is one of the best stocks to buy for long-term investors.
In a nutshell, eyeballs and ad dollars are both migrating rapidly from linear TV to streaming TV. Roku is turning into the world’s largest centralized access point for streaming TV — something like the “cable box” of streaming TV — and is therefore winning over the lion’s share of those ad dollars in migration. This dynamic will persist for the foreseeable future. As it does, Roku’s revenues, profits and stock price will keep marching higher.
So, I say buy ROKU stock on any and all dips, and hold it for the long haul.
Here’s a deeper look.
Roku’s Huge Quarter
Drilling deeper, Roku’s third quarter earnings report was strong across the board.
Account growth remained elevated in the quarter (north of 40%, versus ~35% growth rates pre-Covid), indicative of the reality that the pandemic has permanently accelerated engagement into the streaming TV channel and that Roku is maintaining favorable competitive positioning in the streaming device market.
Average revenue per user growth rates rebounded in the quarter, which is important because it shows that as advertisers reupped budgets in the quarter, they put many of those dollars to work in the streaming TV channel and specifically on Roku’s platform.
The combination of strong account and ARPU growth trends set the stage for Roku to report 73% revenue growth in the quarter — it’s best revenue growth rate as a public company, ever.
Perhaps more importantly, profit margins made significant progress in the quarter. Platform gross margins — which have been in a downtrend for several quarters — started to stabilize in the quarter behind enhanced ad demand. Expense growth meaningfully lagged revenue growth in the quarter, so the operating expense rate dropped more than 10 points year-over-year. Adjusted EBITDA margins, which had been running in negative territory, jumped to 12%.
Head to toe, it was a great quarter. Elevated account growth. Rebounding ARPU growth. Record revenue growth. Stabilizing gross margins. Soaring operating margins. Everything trended in the right direction for ROKU stock in the quarter.
The Great Streaming TV Migration
Zooming out, Roku’s strong earnings report emphasizes that ROKU stock is a great long-term buy because the company is at the epicenter of the enormous pivot in eyeballs and ad dollars from pay TV (or PTV) to connected TV (or CTV).
We are all aware of this pivot because we are a part of it. Consumers everywhere are cutting the cord, ditching PTV and adopting CTV because streaming services’ offer better pricing, enhanced convenience and seamless access.
Traditionally, the number of PTV households in the U.S. has dwarfed the number of CTV households. But in mid-2018, those two numbers became equal for the first time ever. In 2020, the number of CTV households is greater than the number of PTV households. The delta is only widening.
Of course, this has led to a surge in CTV ad spending, because ad dollars chase eyeballs. Still, only about 10% of U.S. TV ad spending happens through CTV channels today, which makes no sense when you consider that U.S. consumers watch more CTV than PTV.
Over the next several years, this discrepancy between CTV ad spending and CTV consumption will narrow, as more and more advertisers are freed up from their PTV contracts, and migrate those ad dollars into the CTV channel.
This is not a small transition. More than $160 billion are spent every year on TV advertising. So, in essence, the Great CTV Ad Shift is a $100-plus billion shift.
Roku is at the epicenter of this enormous shift.
The Growth Flywheel
Roku has established a positive growth flywheel which ensures that the company will forever remain the most commonly used “cable box” of CTV.
Roku is a marketplace which connects streaming services with consumers, and consumers with streaming services. As is true with any other marketplace, the core value prop of Roku to streaming services is to connect them with as many consumers possible, while the core value prop to consumers is to connect them to as many streaming services as possible.
With that in mind, here’s the growth flywheel which ensures dominance for Roku as the ubiquitous “cable box” of CTV for the foreseeable future.
Create a big base of users. Leverage that base to attract streaming services looking for users. Use streaming service wins to attract more users looking for more streaming services. Lather. Rinse. Repeat. All the way to market dominance.
Breaking that down, Roku already is the biggest CTV software ecosystem on the planet. So, if you’re a media company and you are launching a new streaming service, you are going to have to launch that streaming service through Roku.
Once you do that, Roku now has another streaming service in its library, which increases the attractiveness of the platform to users, so more users buy Roku sticks or TVs. That increases the size of the user base, so when the next media company launches a new streaming service, they are going to have launch that service through Roku.
Pretty simple, right?
So long as this growth flywheel continues to spin, Roku will remain at the epicenter of the great CTV ad spending shift — and ROKU stock will project as a long-term winner.
Plenty of Upside Potential
When you look at the numbers, it’s clear that ROKU stock has big long-term upside potential.
The company will likely end 2020 with around 50 million active accounts and over $1.2 billion in Platform revenue. That compares to 1.7 billion global PTV households and $160 billion in global TV ad spending.
Thus, relative to its global opportunity, Roku is tapping into just 3% of its addressable user market, and less than 1% of its addressable advertising market.
Those numbers will grow exponentially over the next several years as more and more consumers and ad dollars rush into the CTV channel.
Where will they pan out?
I think ~10% market share in terms of both users and ad spending seems entirely reasonable for Roku. Assuming so, my numbers say that $25 or better in earnings per share is possible by 2030.
Based on a 20-times forward earnings multiple and an 8.5% discount rate, that implies a 2020 price target for ROKU stock of about $240. Sure, that’s slightly below the stock trades today. But Roku has a propensity for overperforming expectations, because of enormous CTV ad spending tailwinds. Thus, my estimates will likely prove conservative — and ROKU stock is probably worth a lot more than $240 today.
Bottom Line on ROKU Stock
ROKU stock is a long-term winner. Plain and simple. Valuation is a slight concern. But not big enough to override very strong fundamental growth trends. So, while I wouldn’t chase this rally, I would certainly consider buying the next dip, with both hands.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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