Roku Stock: A Path To $200

Roku stock (NASDAQ: ROKU), a company that sells streaming media players, digital content, and advertising, has seen its stock decline by close to 17% this year, trading at levels of about $76 per share. This compares to Netflix stock, (NASDAQ: NFLX), which has gained about 44% over the same period. Roku has been weighed down by a mixed advertising market and slowing growth of its platform business. Roku stock currently trades at just about 2.8x forward revenues and 3.2x trailing revenues. Roku remains in the red, with profits likely to remain elusive this year. Does this make the stock expensive? Probably not. In fact, we think Roku stock has the potential to rise close to 3x in the next few years.

Now the decrease in ROKU stock over the last 3-year period has been far from consistent, with annual returns being considerably more volatile than the S&P 500. Returns for the stock were -31% in 2021, -82% in 2022, and 125% in 2023. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, is considerably less volatile. And it has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. But how could Roku possibly regain its footing and rise again? Let’s delve into the company’s revenue prospects to begin with.

Roku’s revenue growth is expected to remain modest this year, rising by about 14%, from $3.5 billion in 2023 to $4 billion in 2024. This reflects challenges in the digital advertising market and a shift toward more affordable streaming plans, which has impacted Roku’s platform revenue. However, growth could accelerate to around 25% between 2024 and 2027, touching $7 billion levels.

So why the potential rebound in revenue growth? Roku’s platform monetization could improve significantly. Engagement on Roku devices has remained strong, with total streaming hours up 20% in the latest quarter. The Roku Channel, its proprietary streaming service, has also seen a 75% year-over-year jump in streaming hours, becoming one of the leading free, ad-supported platforms in the U.S. This channel is poised to boost higher-margin advertising revenue. Additionally, Roku has been enhancing its ad capabilities by partnering with major ad-tech players like The Trade Desk, enabling more precise targeting and optimization. Additionally, with the recent interest rate cuts by the Federal Reserve, U.S. consumer spending could pick up and this could drive a revival in their advertising expenditure in the coming quarters, thus helping Roku’s top line.

Roku Could Turn Profitable

Roku has been continuously loss-making in recent years, and the company is looking to cut costs aggressively. Over the first six months of this year, the company’s operating costs fell by about 10% driven by workforce and office space reductions in 2023. Roku is also generating more cash. Free cash flow stood at over $300 million for the trailing 12 months. As the company’s past investments in R&D and product development start paying off and as Roku’s business gains scale, it can boost margins meaningfully. For perspective, other companies in the advertising and media space such as the Trade Desk and Netflix had net margins of approximately 10% to 18% respectively, in recent quarters.  If we assume that Roku can boost margins to about 10%, and factor in our revenue projections of roughly $7 billion by 2027, a net income of $700 million is possible by 2027.

Roku’s Multiple Could Expand

Now if Roku’s revenues grow 2x by 2027, the P/S multiple will shrink to half of its current level, assuming the stock price stays the same, correct? But that’s exactly what Roku investors are betting will not happen! If revenues expand 2x over the next few years, instead of the P/S shrinking from around 3x presently to less than 1.5x, a scenario where the P/S actually rises is possible. Why? Netflix trades at a P/S of about 8x, while The Trade Desk trades at about 20x. Moreover, Roku stock itself traded at levels of over 30x revenue during the Covid-19 pandemic. Now if we assume that Roku’s P/S multiple expands to about 5x, considering higher revenue growth and profitability, this would mean that revenue would grow about 2x, while the P/S multiple would rise by about 1.66x. This in turn could 3x the stock from levels of about $76 presently to over $220.

What about the time horizon for this positive-return scenario? While our example illustrates this for a 2027 timeline, in practice, it won’t make much difference whether it takes two years or four.  If the turnaround takes hold, we could see meaningful gains in the stock. 

While investors have their fingers crossed for a soft landing by the U.S. economy, how bad can things get if there is another recession? Our dashboard How Low Can Stocks Go During A Market Crash captures how key stocks fared during and after the last six market crashes.

[1] Returns as of 9/22/2024
[2] Cumulative total returns since the end of 2016

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