Before we get into the reasons I feel this way, however, let me first say that I’ve never been a fan of investing in money-losing publicly traded companies. That’s an activity better suited to private companies where quarter-by-quarter gains aren’t the goal of the business, long-term viability is.
That said, both stocks are on fire in 2017 — Wayfair is up 90% year-to-date (through Nov. 20); ROKU stock is up 179% since its Sept. 27 IPO — so it’s only natural they’re seeing significant investor interest.
I’ve got three big reasons I’d buy ROKU stock before Wayfair. By the end of this article, I’m confident you’ll feel the same.
The numbers say Wayfair’s 39% revenue growth through the third quarter of 2017 is higher than Roku’s 29% revenue growth through its third quarter (which ended on Sept. 30). Not only that, but Wayfair’s revenues are $3.3 billion — ten times Roku’s $325 million.
It’s a lot harder to move the revenue needle on billions of dollars in sales than it is on millions of dollars. On the surface, what Wayfair’s accomplishing is mind-blowing… until you consider the difference in the size of transactions between the two companies.
In its most recent quarter, Wayfair’s average order value was $250; Roku’s average revenue per user (ARPU) in the trailing four quarters was $12.68. Wayfair sells a few hundred sofas a day to drive the numbers; Roku does it with millions of users streaming video.
In the first nine months of 2017, Wayfair’s average order decreased by 0.8% whereas Roku’s ARPU increased by 37%.
Translation: Wayfair has to keep adding new customers to grow the top line — customers that may never be profitable — while Roku can do it organically by increasing its advertising revenue without any additional users.
Now, don’t get me wrong: for ROKU stock to become profitable, it has to continue to add users, but it’s not nearly as vital to the growth of its business as it is for Wayfair.
“Rapid adoption of our advertising, audience development and content distribution services drove Platform revenue growth of 137% year-over-year to $57.5 million, and was 46% of total revenue in the third quarter of 2017, up from 27% in the prior year,” noted Roku’s Q3 2017 earnings release.
As that 46% moves higher, Roku shifts from red to black ink; Wayfair’s road to profitability is far less certain.
Road to Profitability
However, it’s farther up the income statement, at gross profits, that we get a better picture of each company’s profitability today and, potentially, tomorrow.
In the first nine months of 2017, Roku’s gross margin was 39.0%; in 2016 over the same period, its gross margin was 30.4%, 860 basis points lower.
Wayfair’s gross margin over the first nine months of 2017 was 23.4%; over the same period in 2016, its gross margin was also 23.4%.
The most significant eye-opener was each company’s gross margin improvement in Q3 2017. Roku’s gross margin year-over-year improved by 37% to 40.0% compared to zero growth for Wayfair — a fact Wayfair shareholders ought to be concerned by.
Take a closer look at Roku’s two platforms’ gross margins. The Player segment in Q3 2017 was 7.9%, 540 basis points lower than a year earlier. The Platform segment, which I referenced earlier and includes advertising, increased by 570 basis points to 77.5%.
Roku uses its hardware to grow the active number of accounts — they rose by 48% in Q3 2017 to 16.7 million — which generates more ad revenue at 77.5% gross profits rather than 7.9% from its players.
There is no comparison.
The cost of Wayfair shipping all of its products to customers is far more expensive than Roku shipping its players to suppliers and maintaining a sales force to sell ads.
The more accounts Roku gets, multiplied by higher streaming hours, equals higher advertising rates. The economies of scale are tremendous.
What’s Wayfair’s economies of scale? Lower shipping rates? In September, I called Wayfair one of the biggest surprises of 2017 — and not in a good way.
“The fact that both its average order value dropped seven dollars in the first six months of the year to $241 and its net revenue over the past 12 months per active customer dropped by two dollars to $402 suggests to me that its business is slowing slightly,” I wrote Sept. 28. “On the plus side, its operating expenses as a percentage of revenue dropped by 280 basis points in the second quarter to 27.3%.”
By comparison, Roku’s operating expenses as a percentage of revenue are 56% higher than Wayfair’s. At first, that might seem like a victory for Wayfair, but it isn’t, because once Roku grows to a certain number of accounts, it’s operating expenses will begin to flatten and operating margins will increase substantially.
Bottom Line on ROKU Stock
If I were to buy a money-losing stock, Roku stock would be at the top of my list.
Wayfair? Not so much.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.