NFLX Stock: Are the Good Days Over for Netflix, Inc.?

NFLX StockWhat’s Next for Netflix Stock?

Netflix, Inc. (NASDAQ:NFLX) stock’s recent journey was almost as dramatic as its TV shows. How did Netflix stock—the top gainer among all S&P 500 companies last year—become such a shaky one?

Well, valuations certainly played a role. As is the case with many of Netflix’s peers in the Internet industry, it’s not that easy to value Netflix’s business. The company is already the market leader, but it has also opened up new markets. With penetration rates being uncertain and capital spending still high, views on how much the company is worth can be far apart.

That’s part of the reason why NFLX stock could tank even after a solid earnings report. The company reported first-quarter results after the closing bell on Monday, April 18. Netflix added a record 6.74 million subscribers, 38% more than the year-ago period. Its worldwide subscriber base expanded to 81.5 million, with 42% of subscribers coming from outside of the U.S. (Source: “Q1 2016 Letter to Shareholders,” Netflix, Inc., April 18, 2016.)

Financials also turned out to be solid. Revenue came in at $1.96 billion, slightly below analysts’ expectation of $1.97 billion. The bottom line was where Netflix truly shined: the company reported $0.06 in earnings per share (EPS), double Wall Street’s EPS estimate of $0.03.

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Still, a solid earnings report did not boost Netflix’s stock price. On the day following the release, NFLX stock plunged 13%.

In all fairness, a double-digit decline shouldn’t really come as a surprise given where the stock has been since last year. Netflix shares soared through the roof in 2015, surging more than 130%. Then came the downturn, in which Netflix stock tumbled more than 36% from December to February. But from then until mid-April, the stock went on another 30% climb, right before its earnings.

NFLX stock was vulnerable not only because the climb was so quick, but also because of the company’s high valuations. Even after last week’s drop, Netflix stock is still trading at over 330 times (X) its earnings. Its forward price-to-earnings multiple is also above 90X. At this kind of valuation level, even the slightest sign of a slowdown in Netflix’s business could spark a downward trend.

Looking at the details, the bearish sentiment came from Netflix’s forward guidance. The company expects to earn just $0.02 per share in the second quarter, significantly lower than analysts’ estimate of $0.05 in EPS.

The most looked-at number—net subscriber additions—might also be disappointing in the second quarter. Wall Street analysts were projecting 586,000 net U.S. subscriber gains and 3.5 million international subscriber gains. Netflix’s guidance was for 500,000 net domestic adds and 2.0 million net international adds.

The much lower guidance on international subscriber gains really spooked the market. Netflix opened up 130 additional markets back in January. Its on-demand video streaming service is almost fully global, with the exception of China. Investors were counting on international subscriber growth to boost the company’s financials.

That being said, Netflix is still going in the right direction. The company’s monetization efforts have certainly worked. In the U.S., average revenue per user (ARPU) increased three percent year-over-year. The U.S. contribution margin also widened to 35.5%, a sizable improvement from 31.7% in the year-ago period.

Internationally, things are equally impressive. Excluding the impact of exchange rate fluctuations, international ARPU increased seven percent year-over-year.

Note that right now, more than half of Netflix’s subscribers in the U.S. are still paying $7.99 or $8.99 for its $9.99 HD two-screen plan. The company is going to phase out this grandfathering by the end of 2016. Given that Netflix’s service still represents significant value after the price hike, the increase in churn probably won’t be substantial. And Netflix could see further improvement in its top and bottom lines.

The Bottom Line on NFLX Stock

Sentiment aside, keep in mind that Netflix is running a revolutionary business. Moreover, unlike many other disruptive forces in the Internet industry, Netflix has a solid business model in place.

At its current valuation, NFLX stock might not reverse to an upward trend that quickly. But as a company, the future for Netflix is undoubtedly bright.