No one would have ever guessed the big gains 2020 will bring for investors. While the S&P 500's 14% year-to-date rise certainly isn't bad in and of itself, it's been a particularly good year for tech investors. The tech-heavy Nasdaq Composite is up an incredible 45%.
With so many tech stocks rising rapidly this year, many of the market's best companies now trade at valuations that are difficult to justify. So it might be surprising when you hear that my top stock pick is a tech stock that already soared more than 160% over the past 12 months.
My top stock for 2021 is none other than Roku (ROKU -1.20%) -- a streaming-TV platform specialist you have a good chance of already being familiar with, at least from the perspective of a consumer. After all, Roku dominates the smart TV operating software market in the U.S., with approximately a 38% share of the lucrative and fast-growing space.
Image source: Getty Images.
Staggering growth
A surface-level look at Roku may leave you thinking the stock is overpriced. Indeed, shares currently trade at nearly 30 times sales. This is about triple Facebook's price-to-sales ratio. But a deeper understanding of the company's fundamental momentum and its massive market opportunity show why this stock is worth paying up for.
First and foremost, investors should realize that Roku's revenue is soaring. Total revenue was up 73% year over year in the most recent quarter. Platform revenue, which accounts for 70% of total revenue, soared 78% year over year. With growth like this, Roku's price-to-sales ratio can come down rapidly, consider that the stock is trading at 19 times next year's sales.
Importantly, Roku's uncanny revenue growth is fueled by some powerful catalysts. For instance, the company's active accounts, streaming hours, and average revenue per user increased 43%, 54%, and 20% year over year, respectively, in Q3. While some investors might assume these figures are a big acceleration from pre-pandemic levels, when people weren't sheltering at home, that's not the case. Fourth-quarter 2019 active accounts, streaming hours, and average revenue per user rose 36%, 60%, and 29%, respectively. The point is, Roku has carved out a leading position for itself in a fast-growing, resilient market tailwind. It's rapid revenue growth rates, therefore, will likely persist. Sure, some deceleration will naturally play out over time. But any deceleration will likely occur very gradually.
A massive market opportunity
But here's where Roku's growth story gets even more compelling. As the provider of the dominant connected-TV (CTV) platform, the company gets to take part in all major CTV market tailwinds -- whatever they prove to be. With 46 million active accounts, the Roku platform is critical for any publisher when it comes to reaching a mass-market audience. Whether shows get customers through ad-supported or subscription-based programming, Roku will get a share of the economics.
The TV advertising market, in particular, looks like an enormous opportunity for Roku. CTV-based ad spend is expected to total about $8 billion this year, with more than $50 billion of ad spend still going to traditional TV. As sports finally begin making their long-awaited shift away from traditional TV to follow viewers' eyeballs and undivided attention over to streaming, this costly content will still need to be ad-funded. It's simply too expensive to go on without it. Even more, the sports advertising opportunity is too attractive for marketers to not continue pursuing -- especially in a more targeted, data-driven environment.
Roku has quietly built one of the most valuable advertising platforms for the next decade: OneView. The TV-focused ad platform reaches four in five homes in America. As ad dollars continue shifting away from traditional TV to streaming, Roku is well-positioned to capture a large share of this spend.
A Roku-powered TV. Image source: Roku.
A reasonable valuation
Still, some investors might have some hesitations about Roku's valuation. Even a valuation of 19 times next year's sales is quite a premium. Further, Roku is still in investment mode. This means meaningful profits could be years away.
Nevertheless, I believe some simple projections can help illustrate why Roku stock deserves its current valuation. Building on analysts' average forecast for 2021 revenue of $2.4 billion, annual revenue could land at $25.5 billion by 2030 if Roku manages to average a 30% annualized growth rate beyond 2021. Assuming the tech company can achieve a 20% net profit margin on those sales (about two-thirds of Facebook's 30% net profit margin today) and command a price-to-earnings ratio of 30, Roku could have a $153 billion market capitalization in 2030, up from a $46 billion today.
This projection is undoubtedly oversimplified. It could prove to be far too conservative or even a bit aggressive. But given Roku's massive opportunity to gain share from traditional TV in the U.S. alone, and the fact that Roku is just barely getting started internationally, this back-of-the-napkin math is enough to keep me betting on this fast-growing tech company -- even at its valuation today.
What are the risks?
As is the case with any individual stock, there's no guarantee that an investment in Roku works out. Not only should investors expect wild volatility since this is a growth stock, but it's possible that unforeseen challenges arise or that competition proves more formidable than expected. Roku's competitors are deep-pocketed tech giants, including Alphabet, Apple, and Amazon -- and they mean business.
But I believe Roku's positioning as the independent platform, as well as its early market share leadership, are likely enough to continue winning favor with content publishers, marketers, and TV watchers. Roku's negotiating power with these key stakeholders is likely to continue improving. Over the long haul, therefore, I believe that today's investors in Roku stock have a good chance of being rewarded handsomely.
