Known to consumers mostly for its hardware devices and integration with smart televisions, Roku (NASDAQ: ROKU) has become a leader in the streaming space. Its revenue comes primarily from selling ads — and as advertising shifts away from linear TV and more toward streaming, Roku is positioned to benefit.
Yet, when Roku reported its second-quarter 2022 earnings, the market reaction was swift and severe, and the stock dropped almost 18% the next day. There’s no doubt that there were weak headline numbers and troubling guidance in the report.
However, Roku’s path to long-term success is still on track. After digging in a little deeper into the results, I’m not selling. Let’s look at why.
The business model is on track
Roku’s business model is simple to understand. By creating inexpensive streaming devices and an easy-to-use operating system, Roku believes it can continue to grow its user base. Once on the platform, the ability to watch content from any provider should lead to continuously increasing streaming hours. And the more users and streaming hours, the more advertising revenue can be generated.
Looking at the Q2 results through this lens, the numbers look stronger than the market reaction might indicate. Year over year, active accounts grew 14%, streaming hours increased 19%, and average revenue per user (ARPU) came in at a record $44.10. With growth in all three of these important metrics, it’s clear that the business plan is on track.
A skeptic might point out the pace of growth has slowed. However, this quarter is being compared to a particularly strong Q2 2021, when growth was accelerated due to the pandemic. Additionally, Roku’s management clearly stated they saw a pullback in advertising spending this quarter, making the fact that ARPU increased even more impressive.
If we take a step back and look at the growth of these three metrics over a longer time frame, it changes our perspective. Let’s compare Q2 2018 to the most recent quarter.
As you can see, the compound annual growth rate (CAGR), which shows the rate of growth if it were distributed evenly over that time frame, is impressive. By looking at the CAGR of these metrics, it removes some volatility and shows longer-term trends.
Short-term challenges but long-term potential
Roku is going to face some tough times in the near term, which was made apparent by the weak guidance the company issued for the current quarter. Management is expecting Q3 revenue to grow only 3% year over year, and it withdrew full-year guidance. This is likely what drove much of the stock’s drop after the report was released.
However, there are some industry trends that bode well for Roku over the long term. First, Roku remains the top-selling TV operating system (OS) in the U.S., and the second-most-popular OS in Mexico. In addition, Roku users averaged 3.7 hours of streaming hours per day as compared to 7.5 hours of legacy (nonstreaming) TV watched by the average U.S. household.
The market opportunity to capture more of that viewing time appears to be trending in Roku’s direction as well. Next year, less than half of U.S. households are expected to have legacy pay TV, and that number is projected to be 42% by 2026. Roku’s position in the streaming space makes it poised to capture market share as this trend continues.
So is Roku worth it?
If you’re looking for short-term gains, Roku is not the best place for your investing dollars. However, I have a much longer time horizon, and I see compelling reasons to hold Roku for years to come. After the recent hit to the stock price, Roku is trading for a price-to-sales (P/S) multiple of 3.6, near its all-time low of 2.7.
Nothing is certain in investing, and I will be closely watching Roku over the coming quarters to ensure the metrics mentioned above continue to trend in the right direction. But in my view, there’s no reason to sell, even after the recent quarter.