Is it a good time to buy Roku stock?

2022 has been a tough year for stocks deemed winners of the pandemic. A great example of this is Roku (ROKU 2.85%), one of the leading video streaming platforms. At one point since the start of the pandemic, shares rose more than 600% as investors flocked to the video streaming opportunity, but Roku stock has since fallen, now down 60% since the beginning of the year. Investors are worried about slowing account growth — a vital metric for Roku’s business — and supply chain challenges eating into margins.

So is now the time to buy cheap Roku stock?

Image source: Getty Images.

Strong first quarter results clouded by supply chain issues

Roku has had strong results lately, but it also faces some concerning trends that need to be addressed. In the first quarter, the company’s platform revenue grew 39% year-over-year to $647 million. This segment now represents 88% of overall sales and includes advertising, revenue sharing agreements and promotions on the Roku platform. With high gross margins of around 60%, this will be the most important driver of long-term shareholder value.

While the platform’s revenue has steadily increased, supply chain disruptions and increased demand during the pandemic are creating two headwinds for Roku’s business. First, rising hardware costs caused the player/TV segment to post a negative gross margin of 17.4% last quarter. This is a headwind for Roku’s earnings potential, and hopefully it will resolve over the next few quarters. Second, user growth also slowed with only 1.1 million active accounts added quarter over quarter. Roku isn’t small with 61.3 million active accounts, but investors should always expect that number to grow over time so revenue continues to climb.

Great long term opportunity

The optimism behind Roku stock stems from the long-term tailwind for Internet-connected televisions (CTVs) and streaming video. The sector is taking market share from traditional cable video providers every year, and for the first time in early 2022, the reach of streaming TV devices exceeded that of traditional pay TV with an audience of 18 to 49. years, according to the company. . If you think legacy TV will only decline over the next decade, Roku will be able to increase its active accounts and broadcast hours on its platform, allowing it to generate more revenue through advertising and its other agreements.

Roku’s big concern is that TV ad dollars aren’t migrating to broader streaming services, but to YouTube. AlphabetThe video platform is a behemoth with around 2.6 billion monthly active users worldwide and $6.9 billion in ad revenue last quarter. That’s more than double Roku’s $2.9 billion in revenue over the past year, and YouTube claims the majority of the digital video advertising market.

The video streaming industry is expected to be worth over $100 billion in a few years, and many of these services will generate revenue through advertising. However, if YouTube continues to gobble up the lion’s share of this opportunity, it will be a big challenge for Roku. Although many users access YouTube through Roku’s platform, the company does not make money from the app.

Valuation is tricky

At today’s prices, Roku trades at a market capitalization of around $13 billion. Over the past 12 months, it has generated $1.45 billion in gross profits, which have skyrocketed during the pandemic. This gives the stock a gross price-to-earnings ratio of 9.3, which is slightly above the market average. The company doesn’t earn much in terms of net profit or free cash flow, but that’s because it’s still investing heavily for growth.

Chart ROKU Gross Profit (TTM)

Data by Y-Charts.

Two factors should help Roku steadily increase its gross profit. The first is the continued tailwind of streaming video and advertising, which we discussed above. But second, the recovery in hardware margins as supply chains normalize should help boost the company’s overall profitability. This current drag may well turn into a tailwind over the next two to three years and help gross profit continue to rise.

In the long term, investors should expect Roku to turn its gross profit into free cash flow. But for now, the stock looks fairly valued based on its gross profit and growth potential.

So is the action a buy?

Given its growth opportunity and valuation, Roku stock may do well going forward. The only caveat is that you need to be sure that Roku can continue to expand its reach with an increase in active accounts and streaming hours. If this does not happen and growth stalls, yields will be below average.

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