Right now, Roku (NASDAQ:ROKU) appears unstoppable. Despite the market’s muted reaction following the streaming-video enabler’s fiscal 2020 earnings announcement, its stock trades at record highs. However, a rosy near-term outlook does not guarantee that Roku’s growth will continue over the next five years. Investors should take a closer look at the stock and Roku’s business to see whether this communications stock can continue moving higher over a longer-term horizon.
How Roku stands out
Roku successfully competes with tech giants like Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG), and Amazon (NASDAQ:AMZN). It offers set-top boxes to enable streaming on older TVs at a significantly lower price point than devices such as AppleTV. The Roku Ultra, its fastest player, costs $99.99 versus $179.99 for Apple’s lower-end streaming solution.
Moreover, Roku imposes fewer limitations. It does not charge users for operating multiple devices within a household, and unlike Comcast‘s Infinity Flex, it does not force users to cancel some of their existing subscriptions, then repurchase channels such as HBO Max and Starz, to watch those services through its own devices.
Additionally, Roku has made the hardware unnecessary in many cases. It now sells software to TV manufacturers for installation onto smart TVs. This gives Roku a built-in advantage by making its service easier to use than an added Xfinity Flex or AppleTV device.
Still, Roku’s largest revenue advantage hinges on its No. 1 TV streaming platform. By attracting more viewers than other streaming ecosystems, it targets customers through ads customized around a targeted demographic.
This tailored approach gives both advertisers and content providers a way to reach desired audiences to drive revenue. Roku’s ad platform accounted for 71% of its revenue in 2020. Consequently, Roku claims a 38% market share in the U.S. and 31% in Canada, according to the NPD Group.
Roku originally served purely as a platform, hosting lots of different companies’ streaming channels without an obvious bias toward any one of them. However, it ended this neutrality with the launch of the Roku Channel in 2017. While that channel did not originally develop its own programs, its push into original content now means that the Roku Channel will more directly compete with platforms such as Netflix that Roku also promotes.
Admittedly, original programming may increase the company’s ad revenue, as popular programming would attract viewership. Still, Roku’s spending on original content will not guarantee the company further increases in viewership. And since customers faced no switching costs when they came to Roku, they can switch to a rival’s product or service just as easily.
A rival start-up probably would not steal away Roku’s customers en masse, since Roku’s market share amounts to a competitive moat. No start-up could quickly match its 51.2 million customers. However, better-resourced mega-tech companies could threaten Roku’s future. Roku’s $60 billion market cap places it at a significant disadvantage to Apple, Google, and Amazon. All three companies have grown to market caps above $1 trillion and hold more than $60 billion each in cash and marketable securities alone. If one of these companies creates (or buys) a competitive edge, Roku could struggle to respond.
Financials and stock price growth
Despite concerns about the future, the company’s financials reflect its current success. In fiscal 2020, revenue increased by 58% year over year to just under $1.8 billion. Also, gross margins also improved slightly to 45%, up from 44% in 2019.
For 2021, the company expects 2021 gross margins to stay in the mid-40% range. Such growth helped Roku’s stock price grow by around 290% over the last 12 months.
Optimism about Roku’s future has likely driven much of the stock price increases. Nonetheless, the increase has made Roku an expensive stock. Its price-to-sales (P/S) ratio now stands near record levels at around 33. Roku sold for about eight times sales as late as last spring and had rarely traded above 20 times sales before last year.
Such elevated levels increase the danger of negative news hurting stock price growth. Both revenue and streaming hours, which increased by 20.9 billion hours to 58.7 billion, grew at much slower rates than the sales multiple.
Additionally, the pandemic increased Roku’s viewership, likely on a temporary basis. This means that viewership could fall (or at least grow more slowly) as the pandemic ends and more people choose an activity besides streaming in their leisure hours. This consumer shift will make it less likely that Roku sustains its current revenue and viewer growth rates in the near term.
Roku in five years
Admittedly, the high sales multiple will probably not stop Roku from moving higher in the near term. However, if bad news took the sales multiple back to the low-double-digits, it could either hammer Roku stock or lead to stagnation. Also, Roku faces risks as it abandons neutrality and continues to compete against mega-tech peers. These market risks and potential for multiple compression could limit its gains over the next five years.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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