Is NFLX Stock at a Tipping Point?
Netflix, Inc. (NASDAQ:NFLX) is a favorite target for ignorant bears. These simpletons are the newbie investors who just look at NFLX stock and judge it on basic ratios like the price-to-earnings (P/E) multiple.
Not only is that an amateurish way to approach investing, but it also doesn’t help you make any money. You’re supposed to be looking for mispriced securities, and unfortunately, those don’t come with a big red sign attached to them.
Smart investors look for where the market’s going, not where it’s already been.
I’m not saying that P/E ratios aren’t an important metric to consider, but context matters. It’s important to examine Netflix’s underlying business model before you decide whether or not the stock will rise.
For Netflix, that means looking at two things: 1) how many subscribers is the company pulling in, and 2) how much money is it making per subscriber. Only then can we truly gauge whether or not there are any gains left in NFLX stock.
At present, we only have Netflix’s subscriber count for 2015. The company pulled in 5.6 million new subscribers during the fourth quarter, 4.0 million of which were from international markets. The results were far above investors’ expectations. (Source: “Netflix Investors Like What They See as International Users Soar,” Bloomberg, January 19, 2016.)
For the whole year, almost two-thirds of new subscribers came from foreign markets, meaning the company’s future depends on keeping that international audience satisfied.
NFLX stock rose 7.7% after the results were announced in January, but I think that’s the tip of the iceberg. The company recently rolled out its flagship service in 130 additional countries, meaning its overseas audience could expand dramatically. (Source: “Netflix Is Now Available Around the World,” Netflix, Inc. web site, January 6, 2016.)
I think we can firmly assume there is going to be explosive growth in new subscribers during 2016. The official numbers will come in at the next earnings release on April 18, but I’m fairly certain that people are going to be signing up.
Here’s why: Netflix is cheaper than traditional cable by a mile. It costs about $0.09 per hour of television as opposed to $0.30/hour for regular cable. And with those savings comes an added sense of control over your content. You watch what you want, when you want.
It is a value proposition that’s proved irresistible in every market. But as for the income side of the equation, things get a little trickier. CEO Reed Hastings has previously stated that Netflix’s margins only grow wider after customers have been hooked on the service for a few years. The early years, he says, are more expensive.
So I don’t expect its profits to soar immediately. There will be a delayed effect, particularly since Netflix will have to keep expanding its selection of original content. However, the company is quietly increasing its monthly fee, and those earnings will kick in during the second quarter of 2016.
Netflix has also started to offer a “Premium” account that lets the user make up to four profiles and watch content in UltraHD. It is a solid move to boost earnings without restricting content from regular subscribers. (Source: “41% of people say they’ll cancel Netflix if the price goes up — here’s why they actually won’t,” Business Insider, April 5, 2016.)
This year alone the company is releasing 600 hours of original content through 30 TV shows, 35 kids’ shows, 12 documentaries, and nine comedy specials.
Once Netflix has customers locked in after two or three years, the profit margins will start to fatten. But we don’t have to wait that long to see a surge in Netflix stock. The market is simply waiting for a hard number on international growth before it prices in the massive earnings potential from overseas. NFLX stock could easily double on that swing.