Roku (NASDAQ:ROKU) has been one of the hottest stocks in the market over the last year. Its shares are up over 230% in 12 months. That has led its stock to be selling at expensive valuations.
The company has many things going for it, to be sure. For one there is a long-run secular tailwind from linear TV to streaming content. Then, unsurprisingly, advertisers are following viewers and increasing spending on connected TV. Finally, Roku is successfully expanding internationally. But is it all enough to earn its expensive valuation? Let’s find out.
Streaming is how people want to watch content
It’s no secret that viewers prefer streaming over linear TV. With the rise of smartphones and tablets, folks want the option to watch movies and shows on all their screens, not just the TV. Moreover, the way the streaming market is playing out, viewers choose the services they want to pay for. That’s a stark contrast from the cable and satellite subscriptions that force you to swallow hundreds of channels even if you only plan on watching a dozen. That tailwind does not appear to be going away anytime soon.
Roku can benefit as more and more people switch from linear to streaming. After hesitating to start, advertisers are following the viewers to connected TVs. Estimates suggest that ad spending on connected TVs will nearly double from $16 billion this year to $31 billion by 2026.
Further, Roku is successfully expanding internationally. It is already the No. 1 operating system in smart TVs in the U.S., and now it’s also No. 1 in Canada and No. 2 in Mexico. The platform works well, and it’s building trust with viewers who recognize if your TV has the Roku platform, you can get access to almost all of your favorite streaming services.
Can Roku grow into its valuation?
The business is built to scale efficiently. It doesn’t cost Roku much more for the next person to stream content. That’s partly why gross profit more than doubled in the first quarter from last year and the company turned a net loss of $54.6 million to a net profit of $76.3 million at the same time.
Roku is still not profitable on the bottom line annually, although it has turned in a few quarters of surprise profit. With companies that don’t turn a profit on the bottom line, you cannot use the price-to-earnings ratio.
Roku’s prospects are good, no doubt. However, when measured by the forward price-to-sales ratio, Roku is trading at nearly 21 times forward sales, near the higher end of its historical range. The expensive valuation is one of only a few hesitations investors have about the stock. Still, if you put Roku on your watch list, you may get an opportunity to add shares at a more favorable valuation during a stock market crash.
Even so, the long-run secular shift into streaming content, the potential for further international expansion, and a business built to scale profitably could make Roku a good value at current prices.
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.