Major Upside Ahead for Netflix Stock
Internet stocks are not the easiest to trade. Their trends can reverse sooner than you can press the “sell” button. Netflix, Inc. (NASDAQ:NFLX) stock investors are quite familiar with this. In just one month, Netflix stock plunged a whopping 20%.
And it’s not like there’s anything fundamentally different about the company. In fact, its performance has been more than solid.
In the first quarter of 2016, Netflix added a record-high 6.74 million subscribers, 38% more than the year-ago period and also higher than its own guidance of 6.10 million. The company’s 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 were also quite impressive. While revenue came in slightly below Wall Street’s expectation at $1.96 billion, the bottom line more than made up for it. Netflix generated $28.0 million in net income, translating to earnings of $0.06 per share, which doubled analysts’ earnings-per-share (EPS) estimate of $0.03 per share.
However, a good performance doesn’t necessarily translate to investor appeal. On the day following its earnings report, Netflix shares tumbled 13%. A month later, the stock is still in the doldrums.
But not everyone is bearish on the company. In fact, a major analyst covering the Internet sector just said that NFLX stock still has the potential to climb above its all-time high.
On Sunday, RBC Capital analyst Mark Mahaney reiterated his “Outperform” rating on Netflix stock with a price target of $140.00. That represents a 57.1% upside potential compared to where the stock is at today. (Source: “Netflix Gets Vote of Confidence From RBC Amid Heightened Skepticism,” Investors.com, May 16, 2016.)
Mahaney believes that the current concerns about the company’s profitability, international growth, and competition are “overstated.” He said, “We still think NFLX can double in three years.” (Source: Ibid.)
That’s a rather bullish call at a time when the market isn’t really upbeat about the company. One of the reasons behind the recent change in market sentiment toward NFLX stock was its valuation.
You see, Netflix runs a great business. Its on-demand video streaming service has become a disruptive force to traditional cable TV networks. Investors loved the company and rewarded Netflix stock with continued enthusiasm. In 2015, it was the biggest gainer among all the S&P 500 companies.
At the same time, Netflix’s price-to-earnings (P/E) multiple went well into the triple-digit territory. Even after the dramatic plunge in recent weeks, the company still carries a P/E of more than 300X. That means investors are paying more than $300.00 for every $1.00 of Netflix’s earnings. The multiple is not only enormously higher than that of the cable TV industry, but it is also higher than most other stock valuations in the Internet sector.
Of course, what investors are betting on is future performance. But based on the projected financials of 2017, Netflix’s forward P/E is still at a substantial 85X, which is not a low number by any standard.
However, there is still a way for Netflix to improve both its top and bottom lines—international growth.
In recent quarters, international subscriber gains have been the main driver behind the company’s overall subscriber growth. Among the 6.74 million users added in the first quarter, 4.51 million came from outside the U.S.
The company also opened up an additional 130 international markets in January. Launching its service in those markets is costly, and investors want to know if Netflix can generate material profits globally.
On that front, the company is making solid progress. On a constant currency basis, Netflix’s international revenue increased 57% year-over-year in the first quarter. Its FX-neutral (constant currency) international average revenue per user (ARPU) also rose seven percent year-over-year. This could just be the start of Netflix’s global expansion.
The Bottom Line on NFLX Stock
Recently, filings to the Securities and Exchange Commission revealed that several hedge funds have decided to get onboard with Netflix stock. In the first quarter of 2016, Melvin Capital bought 950,000 shares of the on-demand video streaming company, worth approximately $85.5 million at today’s price. Blue Ridge also took a new position, buying 1.4 million NFLX shares worth an estimated $126.0 million. At the same time, Hoplite Capital bought 236,456 shares of the company. (Source: “Top U.S. Hedge Funds Bet on Netflix, Yahoo, Consumer Stocks,” Reuters, May 16, 2016.)
Netflix’s business outlook is no doubt quite bright. If the company manages to convince investors about its earnings potential, NFLX stock still has a chance of getting back to an upward trend.