Roku (ROKU 3.65%) monetizes its business in two ways. It generates player revenue from the sale of streaming devices and audio products, and it generates platform revenue through digital advertising and transaction fees. High inflation is a headwind to both segments because discretionary consumer spending slows in response to rising prices, and brands cut their ad budgets to compensate for the softening demand.
This domino effect led to disappointing financial results for Roku over the past year. Revenue increased just 23% to $3.1 billion — a material deceleration from 66% growth in the prior year — and the company generated negative $21 million in cash from operations. As a result, the stock sold off sharply, falling 91% from its all-time high.
Despite the tough numbers, fund manager Cathie Wood thinks the long-term investment thesis is still very much intact. Her asset management company, Ark Invest, has a 2026 price target of $605 per share on Roku, which implies 1,288% upside over the next four years.
Is this growth stock worth buying?
Roku is the leading streaming platform
Roku is the most popular streaming platform in the U.S., Canada, and Mexico as measured by viewing time, but that fact fails to convey its dominance. Roku is so popular in those three geographies that its platform powered 30.5% of streaming time worldwide in the second quarter, while Amazon ranked a distant second with 16% market share.
Roku owes that success to its first-mover status — it debuted the very first streaming device in 2008 — and its superior operating system. While the market became very competitive, Roku OS is still the only operating system purpose-built for televisions, and purpose-built operating systems tend to create a better user experience.
In a nutshell, Roku has a larger user base, and it engages viewers more effectively than its competition. That makes the company a particularly valuable partner to content creators like Netflix and Walt Disney, as well as advertisers. Additionally, Roku is working to further increase engagement by licensing and producing content for The Roku Channel, its free ad-supported streaming service, and that strategy is paying off. Last quarter, The Roku Channel once again ranked among the top-five most-viewed channels on the platform in the U.S.
More recently, Roku announced plans to build its own smart TVs, as well as other smart home devices like cameras, video doorbells, and lighting. Those products could help the company grow active accounts and reinforce its strong position in the online video advertising market, which is expected to grow at 14% annually to reach $362 billion by 2027.
Ark’s valuation model
Roku reported 65.4 million active accounts at the end of the third quarter, up 16% from the prior year. Similarly, its platform powered 21.9 billion streaming hours during the quarter, up 21% from the prior year. Putting those pieces together, daily streaming hours per active account were 3.7 during the third quarter.
Ark estimates active accounts will reach 157 million by 2026, which implies 23% annualized growth. Additionally, Ark expects daily streaming hours per active account to climb to 4.5, and it believes Roku will generate $14.4 billion in revenue in 2026, which implies 43% annualized growth.
Ark also estimates that Roku’s market capitalization will reach $93 billion by 2026, which implies a price-to-sales ratio of 6.5 at that time. That is much lower than its three-year average of 13.5 times sales, and it would be a reasonable price to pay if Roku actually meets Ark’s revenue target.
So here is the question: Can Roku grow its top line at 43% per year through 2026? Well, the company was growing revenue much more quickly than 43% before red-hot inflation threw a wrench into the ad industry, so Ark’s estimate is within the realm of possibility. But it seems unlikely given the current state of the economy. To that end, investors should not buy this stock under the assumption that it will produce quadruple-digit returns any time soon, though I believe returns of that nature are possible over the next decade or two.
With that in mind, Roku is currently trading at 1.9 times sales — near its cheapest valuation as a public company — and it benefits from a very strong position in a large and growing market. That creates an attractive buying opportunity for patient investors.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Trevor Jennewine has positions in Amazon.com, Roku, and Walt Disney. The Motley Fool has positions in and recommends Amazon.com, Netflix, Roku, and Walt Disney. The Motley Fool recommends the following options: long January 2024 $145 calls on Walt Disney and short January 2024 $155 calls on Walt Disney. The Motley Fool has a disclosure policy.