Is This California-Based Company a No-Brainer Buy?

Netflix is the heavyweight champion of streaming services. While less than 20 years ago streaming didn't really exist yet, the company had the foresight to know that streaming would be the next big thing. And that's why it worked on The Netflix Player -- a hardware device that could turn any TV into a streaming device.

Just before launch, Netflix -- based in Los Gatos, California -- decided not to pursue the project, and instead spun it out. The head of the project, Anthony Wood, took his team and set up just down the street in San Jose. And the new company was renamed Roku (NASDAQ: ROKU).

Roku isn't Wood's first rodeo; indeed, Roku means "six" in Japanese, highlighting that he had started five companies before with varying degrees of success. But nearly 20 years into its journey, I believe it's safe to call this venture his most successful.

Since going public in 2017, Roku's trailing-12-month revenue has increased by nearly 1,300%, pushing it past $4 billion annually. But do this rapid growth and scale make Roku stock a no-brainer buy? I don't think so. Here's why.

Roku needs more than growth

To be clear, the adoption metrics for Roku are impressive. According to Nielsen data, people watched more TV content on Roku's platform in May, June, and July than on broadcast TV (July's is the most up-to-date data there is). Over 125 million people use Roku's platform daily, and this equated to over 35 billion hours of video content being streamed in the second quarter of 2025. In short, adoption is stellar.

Things get dicier once we move past the top line. Roku generates revenue in two ways: from its hardware devices and from its operating platform. Its platform revenue is largely from digital advertising. And since the platform segment provided 88% of total second-quarter revenue, I'll focus on that.

In Q2, Roku's platform gross margin was 51%. That's its second-lowest quarterly figure ever (only the third quarter of 2023 was lower). For perspective, the company's gross margin for its platform revenue was well north of 70% when it went public; that's an immense drop-off.

At Roku's scale, annual gross profit from its platform revenue would be hundreds of millions of dollars higher right now if it had simply maintained the margin profile that it had when it went public. And for what it's worth, Roku's market valuation is only $14.5 billion, meaning that level of gross-profit improvement would make a huge difference in the stock price.

There's more that could be said here. But suffice it to say, Roku needs profitable growth for shareholders to enjoy better returns. And the long-term trend has been discouraging.

What if Roku gets it right?

Pinning the problem on a single issue is unwise -- the issues are likely multifaceted. But in the advertising technology (adtech) space, it's important to deliver measurable returns on advertising spending. If advertisers can use an adtech platform, spend money, and measure a profitable return on investment, that advertising platform should generally expect strong demand. And strong demand allows the platform to charge higher prices, boosting profits.

It would seem that Roku's platform isn't in high demand, at least not as high as one would expect at this point. Unless this gets fixed, it may be tough for this stock to outperform the S&P 500. That's why I wouldn't call an investment in this California company a no-brainer.

However, there may yet be hope for this business. As mentioned, Roku still has an engaged audience, and that's important. Moreover, the company is making deals with top advertising platforms, such as its recent partnership with FreeWheel from Comcast's NBCUniversal. It also partnered with Amazon's demand-side platform in June. Those are two of the biggest fish in the pond.

If Roku could deliver measurable advertising wins for its customers, demand would likely take care of itself. Increased competition for its ad slots would drive up prices. And profits would skyrocket if the company could simply make more money from the business it already has.

In short, Roku has all of the pieces to the puzzle. It just needs to put them together.

This is why I continue to hold my shares of Roku: The adoption trends tell me that the company can thrive in spite of competition. And if it finally starts fixing its platform gross-margin problem with increased advertising demand, then Roku's profits -- and by extension its stock price -- could take off.

It's not a no-brainer buy by any means. But Roku stock isn't yet a lost cause.

Jon Quast has positions in Roku. The Motley Fool has positions in and recommends Amazon, Netflix, and Roku. The Motley Fool recommends Comcast. The Motley Fool has a disclosure policy.