Editor’s note: This column is part of InvestorPlace.com’s Best Stocks for 2020 contest. Left Brain Investment Research’s pick for the contest is Roku (NASDAQ:ROKU).
It is safe to say that most of us are ready to put this year behind us. But with less than a month to the U.S. elections and a novel coronavirus vaccine still not in clear sight, investors could still be in for a wild ride. Is Roku (NASDAQ:ROKU) still a good play to ride out potentially volatile markets and round up 2020?
We think Roku has never looked better.
The company has been a big beneficiary of demand for streaming services resulting from the pandemic. “Cord-cutting” was already increasing, but stay-at-home measures catalyzed a surge in sign-ups for streaming services. Netflix (NASDAQ:NFLX) and Disney+ both reported strong gains in subscriber numbers during the second quarter.
The average household now likely has more than one subscription to a streaming service, and the answer to managing multiple services on a single interface is Roku. Its platform is open and non-exclusive to content providers. This is how it has aggregated over 3,000 channels on its platform, and more than 500,000 TV shows and movies. It is one of the two largest TV streaming platforms in the U.S.
Advertising Ramps Ahead of Holiday Season
Roku’s broad selection of content and 40 million active accounts is driving its larger business segment — advertising. Users streamed 14.6 billion hours of TV in the second quarter, or an average of 340 hours during the quarter per user.
This is great news for advertisers. Why? Because they have a wide audience profile and plenty of ad inventory to work their ad dollars. With work-from-home and home schooling still enforced in many areas, and as we move into the holiday season, we should expect advertising activities to ramp in this last quarter. Roku’s management, while cautious about giving detailed guidance for the second half of fiscal 2020, mentioned that it believed revenue would “grow substantially” on a year-over-year basis in the second half of FY20.
Most of that will likely come from Q4.
Connected TV Advertising Is a Massive Opportunity
To see how valuable Roku’s business is, one just needs to look at the numbers for the advertising industry. Advertising is a $590 billion market, according to data from Statista. In the U.S., $242.5 billion was spent on advertising in 2019. TV advertising alone was almost $70 billion last year in North America. The share of Connected TV advertising, the term used to refer to advertising on streaming platforms, is only a fraction (roughly 1%) of overall TV advertising spend.
However, it is the fastest growing segment, experiencing double-digit increases each year. Therefore we believe that at $741 million in platform sales (part of which is advertising) in 2019, Roku is just at the start of a multi-year revenue growth journey.
Recent company developments also give us some idea of the importance of Roku’s ad business. It launched its OneView platform in May of this year, integrating its ad inventory with targeting and optimization capabilities for advertisers. This means they can better manage and measure performance of their campaigns independently. Advertisers can also now buy ad inventory directly from content providers, giving them more flexibility and control to drive their marketing strategies.
The company also introduced its New Shopper Data program during the second quarter, announcing that grocer Kroger (NYSE:KR) is the first partner of the program. This program intends to use shopper data from retailers and Roku’s viewers to give advertisers a better match of its ad inventory for more effective targeting. Roku continues to strengthen its value proposition to advertisers, making it a key destination for brands to reach their consumers.
Best Stocks: Roku Is Winning the Current Media Landscape
Another area that we like about Roku is its winning position in the current media landscape. Traditional linear TV and legacy pay TV services (cable and satellite) continue to lose subscribers as cord-cutting accelerates. Almost 1 in 3 U.S. TV households are cordless now. TV networks have responded to the trend by creating their own on-demand streaming services, and then placing them on the Roku platform for the viewership and advertising.
Comcast (NASDAQ:CMCSA), a media giant that owns NBCUniversal, after extended negotiations, recently reached an agreement with Roku to bring its Peacock streaming service to Roku’s platform. It will also provide NBC content for The Roku Channel, along with an advertising partnership. This signals how the media streaming landscape is tipping in Roku’s favor. Roku will be the first streaming platform to carry Peacock’s service. This opens the door for more heavyweight networks to join the Roku platform in the future. In turn, this would attract more viewers, and eventually advertisers, creating a powerful flywheel effect for the company’s growth.
Not to be excluded from this market is Amazon (NASDAQ:AMZN), which also has its range of Fire devices (Fire TV Stick, Fire TV Cube) that allows users to view content from its Prime Video and other popular channels. Amazon’s offering is comparable to Roku’s. Both companies are now leading the market with their large viewer numbers and broad content library. We think the market is large enough to accommodate the growth of both companies.
Roku on its part has been expanding rapidly. Not only has it been onboarding content providers and adding new content to its Roku Channel, the company has been extending its reach abroad. It is in Canada, and select countries in Europe and Latin America. It is only a matter of time before it expands to the rest of the world.
Valuation Remains Fair with Potential for Upside
With a large total addressable market and strong platform traction, Roku has been growing sales at a four-year compound average growth rate (CAGR) of 37%. It has a leading market position to continue benefitting from the massive opportunity ahead.
Yet, its valuation remains reasonable, even in this market environment for growth stocks. At a forward price-sales ratio of 16.7x, Roku may have further upside. This is especially true if it scores another key network streaming service for its platform or announces its entry into a large market.
Best Stocks: ROKU Is a Long-Term Play Beyond 2020
In sum, we like Roku. The business has many attractive qualities such as a large addressable market and strong competitive position. Importantly, it is also early in its growth curve. Cord-cutting and the shift to streaming services are favorable multi-year tailwinds that will drive platform adoption for the company, strengthening demand for its advertising services.
Although we chose Roku for the Best Stocks of 2020 contest, the stock is a much longer-term play. We see a promising outlook ahead.
On the date of publication, Left Brain Investment Research has no positions in any of the aforementioned securities. However, affiliate companies Left Brain Capital Management and/or Left Brain Wealth Management are long ROKU and AMZN.