They're birds of a feather, often owned together. But which media-streaming stock should you buy first in today's market -- streaming service veteran Netflix(NASDAQ: NFLX) or viewing platform specialist Roku(NASDAQ: ROKU)?
Let's have a look.
The case for Netflix
This ain't your grandpa's Netflix no more, so to speak.
After chasing maximal subscriber growth for about two decades, the company found a new target in 2022.
"Our goal is to maximize long term revenue in each of our markets," management said in January that year, as part of the Q4 2021 earnings report. A secondary target in the same report was "steadily growing our operating margin at an average increase of three percentage points per year over any few year period." The company also expected to show positive free cash flows "in 2022 and beyond."
Investors were skeptical at first, resulting in a steep price dip for Netflix's shares. And I really mean "steep." By May 11, 2022, the stock price had dropped a hair-raising 72.4% year-to-date.
But the newfound focus on profitable revenue growth is paying proverbial dividends.
- After an inflation-inspired slowdown in 2022, Netflix's top-line sales are skyrocketing again. Trailing revenues are up by 17% in the last two years.
- The revenue flows are more profitable nowadays, boosted by higher subscription prices, a new ad-supported plan, and lots of international hits among Netflix's original content. Operating margins expanded from 19.3% to 27.2% over the same period.
- And don't forget the cash profits. Trailing free cash flows were negative to the tune of $27 million two years ago. Now, Netflix has generated $6.82 billion of positive free cash flows in the last four quarters.
So the stock took a brief sniff at fresh all-time highs in early July and remains less than 10% below that price level today. The stock is on a roll, but it's no longer a no-brainer bargain. Shares can be had for 39 times trailing earnings, 7.4 times sales, or 39.5 times free cash flows. These valuation ratios may be reasonable for a growth stock in its prime, but you shouldn't expect big gains from this investment in the near future.
Netflix is a long-term value play at this point, suitable for patient investors wanting to take advantage of the global shift from cable and broadcast services to online streaming. There's a lot of growth left to collect in this emerging industry, but it'll take a while.
The case for Roku
Roku is a very different story. If Netflix is a reasonably priced value stock with decades of continued growth ahead, then Roku is a wildly undervalued growth stock in the same industry.
The third anniversary of this stock's all-time high is just a couple of days behind us. Roku shares are down by a heart-stopping 87.9% from that point. There was a short-lived recovery swing over the winter, but Roku investors ran out of patience around February's fourth-quarter report. The results weren't bad, approximately meeting Wall Street's consensus earnings target and crushing analysts' revenue projections.
But management didn't convince Roku skeptics that the company was ready to tackle fresh competition from retail giant Walmart(NYSE: WMT), who is acquiring the smaller streaming platform specialist Vizio(NYSE: VZIO). Furthermore, the price tag on Walmart's deal suggests that Roku might have been overvalued with a price-to-sales ratio near 4.0 in the first week of February.
Respectfully, I would argue that the market makers are underestimating Roku by a lot.
You can't compare Vizio's 1.3 P/S ratio to Roku's 2.3x value. Walmart's buyout target is shrinking, not growing:
VZIO Revenue (TTM) data by YCharts
It also burns cash while Roku is back to generating cash profits:
VZIO Free Cash Flow data by YCharts
I think it's highly unfair to measure Roku by the same benchmarks as Vizio, but that's what you get today.
Roku is following in Netflix's footsteps in many ways, including its current journey into overseas markets. The profit-seeking policy should follow, but not anytime soon. This company is still in an intense high-growth phase, and the stock should be valued accordingly. In other words, Roku shares look at least 50% undervalued from where I sit, and even more from a long-term point of view.
Why Roku is the better bet
When deciding between Netflix and Roku, it ultimately comes down to your risk tolerance and the length of your investment horizon.
- Netflix, with its established market presence and consistent revenue growth, offers a stable investment if you're craving steady long-term returns.
- Roku, with its sharp decline and radical undervaluation, presents a high-risk, high-reward opportunity.
So there are no losers here and the winner in this battle depends on your point of view.
That being said, I'm not really buying Netflix shares right now but can't help casting bedroom eyes at Roku's "buy" button whenever I find some spare cash to invest. It's one of my favorite ideas right now and I can't wait to see what happens when the digital advertising market completes its recovery from the inflation-based flu.
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Anders Bylund has positions in Netflix and Roku. The Motley Fool has positions in and recommends Netflix, Roku, and Walmart. The Motley Fool has a disclosure policy.
