A cheat guide to dealing with Roku bears

I wrote about the addition to one of my most important posts last week, and it has left a few people scratching their heads. I stand by my decision to snack Roku (NASDAQ: ROKU) – twice – last week, but when I shared my reasoning on Twitter, some questioned the long-term potential of the streaming video pioneer.

I didn’t expect everyone to agree with my optimism when it comes to Roku. The stock has lost about half of its value since its peak this summer. Here’s a sample of some of the hits and concerns about Roku as a buying opportunity:

• Does anyone really see any set-top boxes or peripherals for the new TVs out there in five years? Roku will be going to the cemetery in five years unless he completely changes course in his business.
• Do you think the rest of the investing public will continue to believe in this story of extreme growth, which is implied by a 90x value?
• I switched to Chromecast. YouTube is more important to me than Roku.

You don’t post on social media expecting a uniform nod, and I naturally welcome all dissenting opinions. Considering all angles is what makes someone a better investor. Let me explain why I remain bullish about Roku stock despite concerns about the future of streaming dongles, profit-based valuations, and Roku’s public trading with Alphabet‘s (NASDAQ: GOOG) (NASDAQ: GOOGL) Youtube.

A stream is a wish your heart makes

Let’s start with the dongle. Roku is the leader of this niche, despite the tech giants Google, Amazon (NASDAQ: AMZN), and in a lesser extent Apple (NASDAQ: AAPL) be prepared to sacrifice margins to get their material into your homes. Dongles are inexpensive, starting at $ 20 to $ 30. The stakes have never been higher. Streaming hubs are free for consumers once they find a way to connect, but monetization for providers continues to explode. Average revenue per user generated by Roku is $ 40.10 for the 12-month period through September, up 49% from a year ago.

Roku’s operating system holds nearly a third of the global streaming market, a 31.1% share compared to Amazon’s Fire TV at 16.8%. And that gap has widened over the past year. Dongles can seem awkward, and paying $ 20 and sacrificing an HDMI slot isn’t ideal, but the alternative could be worse.

I was one of the early adopters of smart TVs. I bought one of the original Google TVs ten years ago. I outfitted my vacation home with Samsung smart TVs in 2014. They would be useless without a dongle, which in my case just happens to be a Roku. Why replace a TV because an operating system platform is fading, when a refresh is just a simple dongle purchase?

If you keep insisting that the dongle is dead, how do you suggest people go to streaming services in the future? If you insist it’s in the TV itself, well – good news for Roku. It’s the market leader there, too: it ships as the default operating system in 38% of all smart TVs sold in this country.

Moving on to valuation, judging Roku on its earnings multiple at this point in its growth cycle doesn’t seem fair. The hardware sells at a loss in order to generate higher margin platform revenue in the future. There are also short-term supply chain constraints for the industry.

Calculating the price / earnings (P / E) ratio is not pretty. Roku is trading at over 150 times next year’s earnings, but the multiple improves with Wall Street pros seeing explosive profitability after that:

• 2022: $ 1.50 per share
• 2023: $ 2.92
• 2024: $ 4.79
• 2025: $ 6.93

With profitability expected to more than quadruple between 2022 and 2025, the P / E ratio drops from three digits to 33. This is still a high multiple, but keep in mind that Roku landed at least 333% ahead of analysts’ quarterly earnings targets over the past year. If history repeats itself, the stock is trading at future multiples well below what Wall Street is currently predicting.

The final blow is more current. Roku is in negotiations with Google to extend its app contract with YouTube and YouTube TV. If the parties don’t come to an agreement, it could end updates to the app and prevent new users from accessing YouTube.

Losing YouTube would be a big deal. But you can be sure that Alphabet would also have a lot to lose in this climate of anti-competitive regulatory oversight if it attempted to give Chromecast an increase in market share by moving away from supporting the rival market leader.

Roku continues to be the agnostic darling with thousands of apps available. All the lesser platforms have also had their battles with streaming services. Remember when HBO Max and Peacock weren’t available on Roku at launch? Everything is ultimately resolved when both sides have a lot at stake. Roku is currently the best dog among streaming service stocks, and he has the tools to stay that way.