Pull-Back in Roku Stock Creates Welcome Entry Point for Investors

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Roku (NASDAQ:ROKU) is not the typical technology stock that investors would want to consider first when it comes to streaming content and set-top TV. While those are two distinct markets that Roku specializes in, it faces strong competition from both fronts. And ROKU stock is suffering from it.

On the content side, Netflix (NASDAQ:NFLX) is still growing subscribers at an impressive rate. And on the TV side, electronics firms like LG Display (NYSE:LPL) continue to face weak LCD TV sales. Now that ROKU stock has given up almost 50% of the peak gains from 52-week highs, what is the verdict on the shares?

Roku reported third-quarter revenue growing 39% year-on-year to $173.4 million. Its Nov. 7 report showed that it lost 9 cents a share despite the strong revenue figure. The divergence between the two numbers suggests that Roku faces stiff competition from another giant: Amazon (NASDAQ:AMZN). While Roku sold many streaming media player units, Amazon may have sold more Fire TV sticks. Plus, the Fire comes with Alexa voice remote. The combo costs $39.99, compared to $49.99 for the Roku Streaming Stick+. Roku’s Ultra 4K Player with an enhanced remote has an $89.99 price tag.

To be fair, that pricing comparison and its impact on Roku sales are speculative. The company proved it still has positive momentum. Revenue grew 39%, with platform revenue increasing 74% to a milestone of $100 million. Platform accounted for 58% of total revenue and has strong profit margins. Platform more than doubled from last year and is made up mostly of video ad sales. Still, management said that for the current fourth quarter, platform gross margins will fall modestly because of higher promotional activity for players.

Roku Channel Growth

The stock gets to enjoy valuations similar to Netflix or Amazon because markets believe Roku channel will resonate with its customers. The channel is a top five in terms of engagement and grew faster than any channel in the history of the platform, as executive Scott Rosenberg said on the Q3 conference call. Roku also has a few news channels, which in turn drives more engagement on the platform.

Viewers may also access the Roku platform and get the free content even without the device. It is accessible on the web, on the desktop, and on Samsung. All of this is ad-supported, so the company is not losing money. Plus, the total addressable market of the TV advertising business is something like $70 billion. Just getting a portion of that market will drive revenues higher.

Partnership with Best Buy

Getting TVs powered with the Roku platform is of strategic importance. Best Buy (NYSE:BBY) is a key player and a partner for Roku in getting smart TVs in consumers’ living rooms. In the U.S., one out of every four smart TVs sold were Roku TVs, so the partnership is mutually beneficial.

Meanwhile, in the third quarter, ARPU (average revenue per user) increased 37% from last year to $17. And as the mix of video advertising and content distribution get better, this figure should grow over time.

Risk on ROKU Stock

If there was any cloud over Roku’s Q3 earnings announcement, it was that Comcast Corporation (NASDAQ:CMCSA) the same day said it was building its own version of a box. If Comcast succeeds — that is a big if — Roku’s projected growth rates would fall. But Comcast is coming into the market late. The box will not have the same number of apps to choose from that Amazon and Roku both offer. What Comcast will have is directly marketing the box to its internet customers as a monthly add-on, allowing them to rent shows and movies from Comcast.

ROKU stock’s ~35% drop in the last quarter brings the share price back to June’s levels. On average and based on 9 analysts offering an opinion on ROKU stock, the target price is above $66 (per Tipranks). The 67% potential upside has a good chance of playing out. Roku has the revenue momentum and growing active user base. If markets reward the stock based on user growth metrics, it will give investors a decent return in the year ahead.

Disclosure: the author does not own shares in any of the companies mentioned.

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