When Roku (NASDAQ:ROKU) stock peaked at almost $500, investors thought that the streaming platform leader would sustain user growth.
The bubble in ROKU stock popped when Roku’s Chief Executive Officer recognized the business reopening hurt TV watching. Roku has traded down ever since. Shares are about $180 today.
At the time, CEO Anthony Wood said that people favored more social activities over watching television.
In the third quarter, the Roku device slowed again. The firm also issued light guidance for the fourth quarter. With the stock firmly in a downtrend, investors might bet on better times ahead.
Trend Reversal and ROKU Stock
Roku posted 50% year-over-year (Y/Y) revenue growth, posting $680 million. Platform revenue grew by 82% Y/Y to $583 million.
Gross profit soared by 69% Y/Y to $362 million. The company’s results would have eased investor worries. Instead, the stock continued its trend in the months that followed.
Markets are still pricing ROKU shares at a premium. They are acting as if user growth will continue indefinitely. People changed their behavior during the pandemic.
They replaced outdoor activities with consuming content on Roku’s streaming services. While average revenue per user rose by 49% Y/Y to $40.10, active account growth slowed.
Roku added only 1.3 million active accounts in the quarter from Q2/2021. It has 56.4 million active accounts and would need to upsell services to increase profit growth.
Since the emergence of a new Covid variant, Omicron, governments started re-implementing lockdowns. Countries fear the rapid spread of omicron will strain hospitals.
Yet since its discovery in South Africa, this variant, while more contagious, has proved less fatal to those who have been vaccinated. Governments are more actively developing a policy to encourage individuals to get a third booster shot.
If the government eases lockdowns and travel restrictions, it could help Roku’s growth. The company will add fewer users in the near term, pressuring the stock.
Fortunately, in the second half of 2022, growth will likely normalize. People who delayed purchasing a smart television powered by Roku will do so next. Existing subscribers may buy more services on Roku. Both trends will lead to a rebound in Roku’s revenue.
Fair Value
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Readers should recognize Roku stock scores well on quality.
According to the quant score right, Roku’s prioritization on account growth will pay off. It suffered supply chain disruptions in the last quarter, hurting results.
Once resolved, the gross margin will rebound. Expect Roku’s 91/100 score on quality to rise in 2022. Similarly, Roku’s growth score of 68/100 will rebound later in the year, thanks to new account additions.
Roku is a Wall Street favorite. Most analysts rate the stock as a buy with a price target in the range of $362 to $550 (per tipranks). Simplywall.st models Roku’s growth and valuation implies a fair value of around $440.
Required Catalyst
Investors need Roku to lift its Q4 net revenue guidance before stepping in to buy the stock. The company expects net revenue in the range of $885 million to $900 million.
Roku expects a net income of up to $5 million. Given its market capitalization, markets may grow tired of waiting for the firm to post consistent profits.
For now, shareholders may overlook the potential earnings loss in the quarter. Growth firms typically spend aggressively on marketing and capital investments. They are willing to post losses to invest for growth for the future.
Roku is a dominant streaming platform. It is prioritizing content spending to keep its users from leaving. For example, it invested in the Roku Channel and earned the top 5 channels on the platform by active account reach.
Don’t Underestimate the Risks
Roku player unit sales fell in Q3/2021 on a year-over-year comparison. This is an unfair comparison, as the company experienced an incredible demand spike during the Covid lockdown. The risk is that sales may not rebound as fast as investors expect.
The company launched new 4K streaming sticks. Users may not upgrade older Roku devices if they do not have a 4K television. Still, 4K is the standard. This suggests that users will eventually buy the newest Roku product.
Roku is a popular platform. It does not face any major competition. Content providers must partner with Roku, which strengthens the brand’s worth.
Advertisers need to buy advertising on Roku’s platform as the audience reach grows. Growth investors may overlook the valuation risks and consider a position in this stock.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.
