2 Growth Stocks Wall Street Might Be Sleeping On, but I’m Not

There’s something special about finding “the next big thing” before that thing goes mainstream. Tom and David Gardner recommended Amazon.com and Netflix (NASDAQ: NFLX) years before those online innovators were cool. Without those astute insights, The Motley Fool might not have existed today.

Or you can look at my personal history. I dove headlong into that brand-new “Internet” thing in 1995, spending every spare moment in my Swedish college’s computer rooms to explore the rudimentary world wide web at dial-up speeds. Two years later, I had met a girl in an online game and transferred to her school in Florida, working out the whole transfer process by email.

By the end of the millennium, the office of admissions at my new school wanted me to stay after graduation as their webmaster. And in 2024, I’m still married to that American girl I met on an Icelandic game server 29 years ago and all my work is online. Let’s just say that the internet has been a game-changer for me.

I’m no future-telling oracle, but I did have the foresight to follow the Gardner brothers’ advice years before joining the Motley Fool’s writing crew. And just as I was early to the digital revolution, I may have found two companies currently poised for remarkable long-term growth, similar to the early days of Amazon and Netflix.

Roku took a bottom-line hit in recent years — on purpose

As it happens, the first name on my list used to be a subsidiary of Netflix. Roku (NASDAQ: ROKU) started life as the designer of set-top boxes that could move Netflix’s video-streaming experience from laptop screens to living-room TVs.

The DVD-mailer king struggled in the transition to digital video streams, but astute investors who bought Netflix stock during the Qwikster storm have been handsomely rewarded in the long run. For example, the shares I picked up at the end of October 2011 have gained almost exactly 5,000% so far.

Much like Netflix’s stock in 2011, Roku’s share price is down on unreasonable grounds nowadays. Bearish investors worry about the usual headline numbers — Roku’s sales growth slowed down in 2022 and 2023 while bottom-line earnings dipped into negative numbers. But — stop me if you’ve heard this before — these undesirable financial trends simply reflected how Roku chose to conduct its business during the inflation-tinged economic downturn.

Many companies raised prices in an effort to pass their increased expenses on to their customers. Roku didn’t contribute to the inflationary trend that way. Instead, the company held prices steady in order to win more end-market customers and a larger market share during this difficult period.

As a result, Roku is selling streaming devices below cost. You can call it a marketing expense if you like, and an effective one. The number of active Roku accounts rose from 70 million names in the fourth quarter of 2022 to 80 million users one year later.

Chart source: Roku’s Q4 2023 earnings report.

Oh, and Roku may report negative earnings but its cash profits are positive and rising. The company converted 5% of its 2023 revenues into free cash flows, reflecting generous amounts of stock-based compensation and video content amortization. Keep in mind that cash flows show the movement of actual cash in and out of a company’s bank accounts, while earnings are an accounting construct related to tax reporting. So I don’t mind low or negative earnings alongside robust cash flows — that’s just clever accounting that keeps tax expenses low.

Digital advertising is coming back from the inflation crisis at its own sluggish pace, with the media and entertainment (M&E) sector lagging behind the ad-buying market at large. That’s bad news for Roku, who generates most of its revenues from ad sales with an outsized contribution from the M&E sector. But no downturn lasts forever and I think it’s both shortsighted and unfair to reduce your calculation of Roku’s long-term value based on a temporary challenge.

Yet, the M&E advertising headwind and negative earnings still dominate the stock market’s thinking about Roku and its stock. Share prices stand more than 85% below the all-time highs from the summer of 2021 and 40% down from the annual peaks in November 2023. You can pick up Roku shares at the modest valuation of 2.7 times sales.

That’s a bargain in my book, more suitable for a slow-growth cash machine than an early stage growth phenom. One of these lines is not like the other, and I think it’s just a matter of time before Wall Street gets back to its senses. Roku deserves a much richer valuation and the company has many years of greenfield growth opportunities ahead. You don’t want to be left empty-handed when this goofy discount pricing ends:

ROKU PS Ratio Chart

ROKU PS Ratio Chart

AI-powered voice controls

Next, let’s take a quick look at SoundHound AI (NASDAQ: SOUN). This company provides voice control and audio analytics software and services to auto makers, drive-through restaurants, any business with a phone-based menu system, and more. For example, SoundHound AI has managed the voice-control functions in Netflix’s reference design for set-top boxes since 2019.

Its software relies on advanced artificial intelligence (AI) engines, trained on two decades of song identification services and an ongoing stream of fresh voice-control commands.

SoundHound AI’s deep learning systems produce a better user experience than simpler systems with basic speech-to-text interpretation. And the company has a modest approach to its brand so far — customers are typically free to skip the SoundHound AI and Houndify branding altogether and present their tweaked voice control systems under their own brand names.

So you may never notice that you’re using a SoundHound AI service when talking to ChatGPT in your Stellantis car or ordering burgers at the local White Castle drive-through. Whether you know it or not, that’s the Houndify platform at work, and the client network is growing larger over time.

This is still a very small company, barely scratching the surface of a massive global market. SoundHound AI’s revenues stopped at $46 million in fiscal year 2023, but the company has a backlog of unfilled orders and long-term contracts worth $661 million. That backlog doubled in size last year.

So SoundHound AI is building a rocket engine to drive years and years of terrific business growth. The stock recently soared as AI technology giant Nvidia (NASDAQ: NVDA) revealed a small investment in SoundHound AI, but the stock still trades more than 20% below the price of its initial public offering (IPO) in 2021. With currently tiny revenue streams supported by $661 million in firm long-term order bookings, the stock may look expensive from a simple price-to-sales perspective but affordable in light of the robust bookings backlog.

And don’t forget that voice control and audio analysis specialists have a history of attracting buyout offers. Shazam is an Apple subsidiary since 2018. Nuance Communications joined forces with Microsoft four years later. I can imagine a bidding war breaking out over SoundHound AI if another couple of tech giants want to get an instant foot in the voice-control door without doing decades of advanced voice-based AI research.

Both SoundHound AI and Roku look deeply undervalued right now, especially when you consider the absolutely gigantic target markets they are pursuing. I can’t promise that either one will follow in the market-beating footsteps of Amazon and Netflix, but their growth prospects have inspired me to buy both stocks in recent months.

These spicy growth stocks may not be your cup of tea, but they have a lot in common with how Netflix inspired me in 2011 and Amazon caught David Gardner’s eye in 2002.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Anders Bylund has positions in Amazon, Netflix, Nvidia, Roku, and SoundHound AI. The Motley Fool has positions in and recommends Amazon, Apple, Microsoft, Netflix, Nvidia, and Roku. The Motley Fool recommends Stellantis and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.

2 Growth Stocks Wall Street Might Be Sleeping On, but I’m Not was originally published by The Motley Fool