Time to Bail on NFLX Stock?
If you have been following Netflix, Inc. (NASDAQ:NFLX) stock in recent quarters, you would know that beating earnings estimates is not enough. Last week’s earnings release was the latest proof of Netflix stock’s risky nature. Even though the company beat analysts’ earnings-per-share (EPS) estimates by a mile, NFLX stock still got killed.
The worst part is that Netflix stock was in the doldrums even before earnings. Year-to-date, NFLX stock is down 19.6%. Is there any hope left for the on-demand video streaming giant?
Yes—but first, let’s take a look at the other side of the argument.
The company had a solid quarter in terms of financials. In the second quarter of 2016, Netflix’s revenue surged 27.9% year-over-year to $2.11 billion. Net income came in at $40.76 million, a whopping 54.8% increase from the year-ago period. NFLX stock posted earnings of $0.09 per share, smashing analysts’ estimates of $0.02 per share. (Source: “Q2 16 Letter to Shareholders,” Netflix, Inc., July 18, 2016.)
The reason behind NFLX stock’s latest round of downturns was its subscriber growth. As a company that earns most of its revenue by providing on-demand video streaming services, user growth is key. In the second quarter, the company added 1.7 million members worldwide, which is below its own forecast of 2.5 million net new members and much less than the 3.3 million net additions in the year-ago period.
It doesn’t help NFLX stock’s case that the company just launched its service in 130 additional markets around the world earlier this year. With such a huge expansion of the total addressable market, investors thought that user growth would speed up.
The company blamed the disappointing net subscriber growth on churn (cancellations) due to its plan to un-grandfather longer-tenured members. In the shareholder letter, Netflix said, “We think some members perceived the news as an impending new price increase rather than the completion of two years of grandfathering.” In fact, the churn of members who were actually un-grandfathered was within expectations. (Source: Ibid.)
Still, we have to keep one thing in mind: Netflix is already a huge company.
There are more than 83 million subscribers to its on-demand video streaming service worldwide. Unlike many other Internet companies that earn revenue from advertising, Netflix subscribers are paying $10.00 a month for its service—ad-free.
Of course, that is still just a single line of business. Unfortunately, relying on one business stream is not a welcoming feature in today’s stock market. Companies today are stepping outside of their comfort zones to boost revenue and please shareholders: there is a social media company making virtual reality headsets, and a smartphone maker going after driverless cars, and an e-commerce company offering cloud computing services and drone deliveries. Those businesses are difficult to evaluate, but they do provide sources of future growth.
Now, back to Netflix. Even though the company relies on just video streaming (Netflix’s DVD rental segment, which represents the company’s beginnings, is much smaller in comparison), the segment is doing so well that it’s revolutionizing the entire industry.
According to research firm MoffettNathanson, Netflix was responsible for about half of the overall decline in TV viewing in the U.S. in 2015. The research firm found that Netflix subscribers watched CBS shows 42% less than non-subscribers. They also watched 35% fewer Fox shows, 32% fewer ABC shows, and 27% fewer NBC programs. (Source: “Netflix Caused 50% of U.S. TV Viewing Drop in 2015,” Variety, March 3, 2016.)
Most recently, Comcast Corporation (NASDAQ:CMCSA), one of the biggest cable companies in the world, announced that its “X1” set-top box will support Netflix streaming. (Source: “Comcast to Add Netflix to Latest Set-Top Boxes,” The Wall Street Journal, July 5, 2016.)
Comcast’s announcement is the latest sign that Netflix is leading the trend as people shift away from traditional TV networks toward on-demand content consumption. Don’t get me wrong—Netflix is not going to destroy the cable industry altogether. Rather, it could improve it by being an add-on option to millions of viewers who have cable boxes.
The Bottom Line on NFLX Stock
At the end of the day, valuations could still be a drag for NFLX stock. When a company is trading at nearly 300 times its earnings, any sign of a slowdown in growth could trigger a new round of sell-offs. Still, Netflix is running an amazing business and patient Netflix stock investors could be rewarded in the long term.