As the Federal Reserve plans to cut interest rates in the coming weeks, the market remains on edge. Earnings season has been a mixed bag so far, and there's fear of a retail slump.
Streaming company Roku (NASDAQ: ROKU) reported solid results last week, but its stock didn't move much. It's still down 88% from its highs, but if the company continues in the right direction, its stock won't stay down forever.
More people are watching on Roku
One consistently strong metric for Roku is viewer adoption. Roku had 83.6 million subscriptions at the end of the second quarter, a 14% year-over-year increase, and that keeps moving up sequentially. Streaming hours increased 20% to 31 million. These are key metrics for Roku, because they indicate customer interest and engagement.
Standard financial metrics tell a similar story. Revenue increased 14% year over year in the quarter, with an 11% increase in platform revenue, which is mostly ads and other third-party partnership deals, and a 39% increase in devices. That's high, but devices only account for 15% of total revenue.
The device segment is still sitting with a gross loss , but the devices have a specific role in Roku's model. They bring people into the Roku ecosystem, where they count as members and account for streaming hours, leading to better ad sales and scale. The ad business accounts for the other 85% of sales and has very high gross margin -- 53.4% in the second quarter.
Keeping up the momentum
Management is keenly aware of how to leverage its platform into higher sales. It has the top streaming operating system (OS) in the U.S., Canada, and Mexico, which gives it incredible opportunities to monetize the platform.
Something management recently talked about was leveraging its "home screen." Every Roku member begins their streaming journey on the home screen, including viewers looking for free content, like the Roku channel, and those who have paid subscriptions to networks like Netflix . Roku can still reach premium subscribers with ads on the home screen, and it's aiming to up that experience. It's creating more free programs for its sports enthusiasts, even those watching premium sporting content, such as ones that provide stats and highlights.
It's also using the home screen to drive engagement to The Roku Channel, where it gets much of its ad sales. The Roku Channel was the third-most-watched channel in the second quarter, and streaming hours increased 75% over last year.
Although the device segment is still pulling down profits, Roku is investing in offering better options to entice more viewers. It recently released a high-end collection called the Roku Pro Series, and it's getting rave reviews. These kinds of products are typically higher-margin products , so they have a dual purpose. Roku is also expanding its wholesale deals, such as sales through Target stores, to expand its reach.
But it's still not turning sales into profits
Roku's plans to scale profitability were interrupted by the pandemic. Profits briefly soared, but Roku wasn't equipped to deal with the massive demand, and it fumbled as it shot too high to meet it. That's a similar story to many young, disruptive companies that weren't prepared for pandemic-driven acceleration. Roku has been cutting costs to get to efficient scaling, and although it's taking time, there has been some impressive recent progress.
It still posted an operating loss in the second quarter, but it improved 43% over last year. The second quarter was the fourth consecutive quarter of positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) and positive free cash flow, and management is guiding for $45 million adjusted EBITDA in the third quarter, a slight year-over-year increase.
Net loss improved from $108 million last year to $34 million this year, and management is guiding for a $50 million loss in the third quarter. While not positive, that's a marked improvement.
Is Roku stock a bargain?
Roku stock trades at 2 times trailing-12-month sales. It continues to grow at double-digit rates and is demonstrating improvement in profitability. It enjoys an edge over its device competitors and has wide opportunities to grow its advertising business.
It's not going to become profitable overnight, but if it can keep up these trends, the stock will eventually catch up to the growth. If you have some appetite for risk and a long enough time horizon, Roku stock looks like a buy right now.
Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Netflix, Roku, and Target. The Motley Fool has a disclosure policy .
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