Shares of Netflix Inc. (NFLX, Financial) plunged over 8% last Thursday following the release of its second-quarter earnings report. While the report was predominantly positive, it failed to impress Wall Street, leaving investors uncertain and unenthusiastic.
The decline comes after an impressive year-to-date surge, triggered by the introduction of a more affordable ad-supported plan and a crackdown on password sharing. These initiatives were expected to fuel growth for the streaming giant. However, despite these efforts, the market sentiment has shifted, leading to the recent sell-off in the stock.
Regardless, investors can remain optimistic about the company's ongoing success. Several elements indicate a promising future, including Netflix's capacity to leverage its wide-ranging user base, improve profit margins and create greater free cash flows.
The streaming giant's core strategy is delivering content and maintaining a clear revenue structure. I do not see any major change, so I remain optimistic about its outlook.
Earnings review
Netflix's earnings report showed mixed results, leading to a decline in its shares. While the company attracted nearly 6 million new subscribers, its net income of $1.49 billion increased from the prior-year quarter. Its earnings per share of $3.29 also topped estimates of $2.86. Revenue of $8.19 billion fell short of analysts' projections of $8.30 billion.
Further, the company's forecast for third-quarter revenue of $8.52 billion was below analysts' projections of $8.67 billion. Netflix Chief Financial Officer Spencer Neumann remained optimistic, expressing confidence in the company's performance and anticipating revenue acceleration.
Response to challenges
The company's efforts to tackle subscriber growth, included raising rates, introducing cheaper ad-based subscriptions and addressing password sharing among non-cohabiting users, appear to be paying off. Although the company faced a decline in early 2022, it has recorded a rebound in new subscribers.
In response to the ongoing Hollywood strikes, Co-CEO Ted Sarandos expressed dissatisfaction with the lack of progress. Still, the company increased its free cash flow for the year to around $5 billion due to lower cash content spent amid the strikes.
Despite these initiatives, investor sentiment was not positively impacted by the quarterly figures, leading to a reversal. Nevertheless, given its recent strategic measures, the company's growth story remains compelling.
Why slowing growth is not a problem
The prospects for Netflix's ongoing success and potential growth are based on a multi-faceted investment thesis. Several crucial elements contribute uniquely to its robust position in the streaming market.
First, Netflix strategically aims to rekindle growth through various innovative efforts, such as its stance against password sharing and introducing an ad-supported tier. These measures show early signs of success and are designed to increase subscription numbers and revenue.
Second, the company is well-positioned to take advantage of the difficulties faced by its competitors, which could allow it to increase its market share. This also allows Netflix to augment its content library through strategic licensing agreements, thus attracting more subscribers.
A third key factor is the evolution of the broader market, with the growing streaming industry representing a substantial opportunity for Netflix to penetrate further into the market.
Financial prospects
From a financial perspective, Netflix's prospects are encouraging. The potential gain in market share and a promising upcoming content slate suggest higher-than-anticipated growth in the near to mid-term. The company also aims to achieve Ebit margins exceeding 20% by introducing a more profitable ad tier and benefiting from operational efficiencies due to its increasing scale.
Despite investments in new content and currency fluctuations affecting its operating margin, the company expects positive margin shifts, increasing from 18% in 2022 to 20% in 2023. This is expected to result from stabilizing revenue growth, a weakening dollar, cost-cutting measures and entering the high-margin ad sector.
The projection of these healthy margins suggest Netflix will likely remain the only profitable streaming platform. In summary, combining innovative strategies, savvy market positioning, the potential for market expansion and solid financial objectives strongly back the forecast for Netflix's continued growth and market dominance.
Valuation is normalizing
Netflix's financial analysis reveals a complex situation for investors. While the company is expected to have healthy revenue and earnings per share margins, its stock is not considered significantly undervalued. Currently trading at 45.53 times earnings, the stock is relatively expensive compared to traditional valuation metrics.
One key factor influencing Netflix's market perception is its inclusion in the FAANG group. This categorization emphasizes growth and technological innovation over traditional valuation metrics, contributing to the historically high price-earnings ratio.
Over the past decade, the company's earnings multiple has fluctuated significantly, with a minimum of 15.93, a median of 127.44 and a maximum of 629.53. The current price-earnings ratio of 45.53 is still considerably higher than the industry median of 18.10, indicating shares are more expensive relative to earnings than most of its peers in the diversified media industry.
However, Netflix's classification among the FAANG group means that investors view it differently, focusing more on growth prospects, market leadership and its disruptive business model. Despite its high price-earnings ratio, the company remains an attractive option for those with a long-term growth strategy.
Were the company's subscriber and revenue growth to slow down significantly, there might be a risk of reclassification as a traditional media company, leading to a revaluation of its stock.
Investors should understand that rather than traditional metrics, Netflix's valuation is driven more by growth and market potential. Long-term growth-oriented investors may continue to find value in the company, while conservative investors seeking immediate returns might explore other opportunities within the media industry.
Takeaway
While the stock may not be considered a bargain, Netflix's ability to consistently generate revenue growth and adapt to changing consumer preferences solidifies its position as a best-in-class player.
As the streaming market continues to expand, Netflix's strengths and market leadership position it well for future success, making it an attractive choice for investors seeking to capitalize on the long-term growth potential of the entertainment industry.
