Will Roku 10X?

Streaming television platform Roku (NASDAQ:ROKU) is a longstanding favorite of Cathie Wood’s ARK investment funds.

 

Roku is the investment company’s third-largest holding, making up 4.4 percent of its portfolio. This large position on Roku is based on Cathie Wood’s belief that the stock could rise by as much as 10x over the next few years.

 

ARK’s current price target for Roku is $605 by the year 2026. The question, however, is how realistic this price target is and whether investors should follow Wood’s lead on Roku.

 

ARK’s projected stock price for Roku relies on several key developments for the company over the next four years. First and foremost, ARK believes that revenue will continue growing at a compounded annual rate of 39 percent through 2026.

 

ARK also expects gross margin to rise from 51 percent in 2021 to 59 percent by 2026. This, paired with an increase of monetization rates, should support higher earnings.

 

ARK is very clear in its model that an increase in the gross platform monetization rate is critical to Roku’s success. If ARK’s modeling is correct, Roku will achieve a rate of $0.21 per hour by 2026.

To drive this growth in both revenues and earnings, Roku will require an expanded user base.

 

Under ARK’s model, the company would nearly triple its number of active user accounts. Daily hours streamed per account would also need to rise from 3.6 to 4.5.

 

By 2026, ARK expects Roku to have a potential audience of 1.25 billion households worldwide with smart TVs.

 

Underlying ARK’s thesis for Roku is the idea that streaming TV will continue to deliver high levels of growth going forward.

 

The ARK model relies heavily on Roku’s growth in less mature markets than the US. It also assumes that streaming still has room to grow in developed markets.

 

The investment firm acknowledges that its views on streaming growth are more bullish than other funds but stresses the importance of non-US markets as drivers of ongoing growth.

 

While perhaps not as optimistic as Cathie Wood, analysts generally have a positive view of Roku’s future. The stock’s median 12-month target price is $77.50, 48.2 percent higher than the most recent price of $52.30.

 

Roku currently holds a consensus buy rating, with 18 out of 31 analysts covering the stock recommending it as a buy.

 

Interestingly, analysts largely agree with Wood’s view on the rate of revenue growth. The average analyst growth forecast for the next five years is 43 percent, largely lining up with the ARK projection.

 

This suggests that an increasing number of analysts may subscribe to Wood’s views on high streaming growth rates continuing for several years.

 

Despite bullishness from analysts at large and a massive endorsement from Cathie Wood, Roku isn’t without its share of risks. Chief among the concerns for Roku is that an economic slowdown will harm consumer confidence and reduce advertising spending.

 

This, in turn, could lead to higher prices for streaming subscriptions. Such a turn of events could blunt growth in the streaming industry, potentially reducing Roku’s own growth rate.

 

An increasingly competitive streaming landscape could also weigh on Roku’s growth. As noted by Morningstar, companies are competing fiercely for a share of streaming ad dollars. This could make it more difficult for Roku to maintain its market dominance and, ultimately, affect revenue growth.

 

Insider selling over the last 12 months may also indicate a somewhat pessimistic internal view of Roku’s long-term share prices.

 

Insiders have liquidated $157 million worth of Roku stock in the last 12 months. This includes 320,000 shares sold by CEO Anthony Wood (no relation to ARK’s Cathie Wood) early in the year.

 

Finally, Roku’s slip back into losing territory after achieving profitability in 2020 makes it a risky bet for investors. The company lost $0.82 per share in Q2, down substantially from a loss of $0.19 in Q1.

 

Relatively young startups like Roku that struggle with profitability are inherently riskier than large, well-established legacy businesses. While this doesn’t necessarily rule Roku out by any means, it’s a risk that investors should be aware of before purchasing the stock.

 

While analyst growth projections largely line up with Wood’s expected revenue growth rate, the ARK model seems to reflect an absolute best-case scenario.

 

For Roku to 10X, the company would have to raise its revenues, margins and monetization rates with no bumps along the way for the next four years. Given the growing likelihood of a recession next year, such linear growth seems fairly unlikely.

 

With that said, there are several arguments in favor of buying Roku while prices remain low. To begin with, the company seems to be poised to deliver exceptional revenue growth over the next few years.

 

Both Cathie Wood and more mainstream analysts agree that Roku could see its revenue increase by about 40 percent year-over-year through 2026. Such high growth rates would almost certainly drive share prices higher and result in solid returns.

 

Roku also stands to benefit from an advertiser migration toward streaming platforms. Even though streaming is massively popular, advertisers have been relatively slow to adopt it as a marketing channel. More advertising dollars moving to streaming platforms could help to blunt the effects of increased competition.

 

It’s also worth noting that Roku’s platform gives it something of a moat. Roku is the most widely-used way to access streaming services, and it doesn’t seem likely that another service will be able to easily unseat it. As such, Roku likely enjoys a competitive advantage that could support higher share prices.

 

While Cathie Wood’s price target of $605 is almost certainly too optimistic, it seems that Roku could be a good buy for risk-tolerant investors at today’s prices.

 

More conservative investors, though, may want to hold off to see if the company’s earnings improve. With several years of probable growth ahead of it, Roku’s stock will likely present more than one buying opportunity along the way.

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