Roku Stock is Even More Attractive Following Its Pullback

Because I liked Roku (NASDAQ:ROKU) when the stock was trading at $150, and I don’t expect coronavirus to trigger another Great Recession, (I think the virus’ spread will decelerate greatly within a month or two) I’m even more bullish on Roku stock now than I was a couple of weeks ago.

Roku Stock is Even More Attractive Following Its Pullback
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Meanwhile, besides the shares’ attractive valuation, I’ve thought of a few more potential positive catalysts for Roku stock.

Excluding its low-margin player revenue, Roku is trading at a little over 11 times its revenue, according to InvestorPlace columnist Vince Martin. Further, the streaming platform’s 2020 guidance indicates that its high-margin revenue from advertising and subscription commissions — the company calls the combined revenue from these two sources “platform revenue” — will jump more than 60% year-over-year, Martin reported. He added that:

“There are not a lot of stocks in this market growing revenue at a 60% clip in 2020. Those that are even in that ballpark often trade at 15 times revenue or more. And so there’s now a fundamental case that — again, on a relative basis — Roku actually is cheap.”

I think that the combination of 60% growth and 11x revenue definitely does make Roku’s shares quite cheap, especially given the company’s huge opportunity ahead.

Hardware Revenue and Competition

But Martin has two main reservations about Roku and Roku stock. Specifically, he notes that the company’s hardware revenue currently carries very low margins, and he suggests that conventional TV providers like Comcast (NASDAQ:CMCSA) and AT&T (NYSE:T), along with big-tech companies like Alphabet (NASDAQ:GOOGL) and Amazon (NASDAQ:AMZN), could chip away at Roku’s market share.

On the first point, I think that Roku’s hardware margins are likely to increase in the medium to long term. As the company begins selling tens of millions more players in the U.S. and around the world, its production costs are likely to drop, pushing margins higher. Moreover, as the Roku brand becomes stronger, the company will probably be able to meaningfully increase its hardware prices, and it will likely release new, higher-margin products.

This trend may have already begun: Roku’s Streaming Stick looks similar to Google’s Chromecast  and Amazon’s Fire TV Stick. But Roku’s product costs $49, while Amazon’s costs $39.99 and Google’s costs just $28.50. Assuming Amazon and Google are breaking even on their products, and that they all cost about the same to produce, Roku’s gross margin on its stick is 22.5%-72%.

Moreover, many TV makers, including Sharp (OTC:SHCAY), TCL, and LG, are bundling Roku’s operating system into their TVs. Since Roku likely doesn’t have to produce much, if any, hardware to get its OS into those makers’ TVs, its margins on those deals are probably pretty high. And, again, as the Roku brand gets stronger — driven by the ease of use of its products, free publicity, and its dozens of content partners — it will be able to charge TV makers more for using its OS.

And as more TV makers incorporate Roku into smart TVs and millions more Americans buy smart TVs which have become much more affordable in recent years, the products from the Comcasts and AT&Ts of the world will become irrelevant for much of the market. After all, almost no one who already has Roku installed on his or her TV would bother taking the time to order and install a competing product from a TV provider, even if the latter product is free. Although the big-tech companies could also make deals with TV makers (Google has made many such deals), Roku appears to have a first-mover advantage over Google, and reviewers appear to view Roku as the best streaming TV system. 

The Bottom Line on Roku Stock

I continue to believe that Roku is poised to become the world’s leading TV provider, and the company continues to have strong positive revenue and margin drivers. The recent pullback in Roku stock has made its shares extremely attractive.

As of this writing, Larry Ramer owned shares of Roku stock. Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been GE, solar stocks, and Snap. You can reach him on StockTwits at @larryramer.

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