Netflix (NFLX) released earnings yesterday and the stock is getting pummeled today. It was a “live by the sword, die by the sword” kind of thing, as the metric that has driven the spectacular recent gains, U.S. subscription growth, faltered.
In fact, it did more than falter. It missed by a mile.
It is little wonder that the stock got hammered: NFLX is down over 13.5% in early exchanges this morning. This is what happens when high expectations are disappointed, but investors should remember that Netflix has a history of responding to challenges, and Wall Street has a history of underestimating them when they do.
There are many things that contribute to a successful company’s success, but one of the most important is their attitude to change. Recognizing trends and opportunities, and more importantly acting on that understanding, is how companies grow. Amazon (AMZN), for example, started as an online book store but has morphed into much more than that. Their success has been spectacular, but until very recently was essentially about growing within the e-commerce space they occupied.
Some must be more adaptable than AMZN just to survive, let alone grow, and in many ways their stories are even more noteworthy. Netflix is a prime example.
It is easy to forget that Netflix started life as a disruptor of what quickly became a dying industry. Video and CD rental was big business thirty or forty years ago, but Amazon’s postal delivery model quickly did huge damage to the brick and mortar rental stores that were so commonplace back then. Only a short time after they had begun to dominate that market, however, it disappeared almost completely. Cable companies began offering movies on demand and mobile technology made streaming possible, so consumers needed no longer to wait for delivery of a movie.
Netflix, however, had learned from the fate of its early competitors such as Blockbuster, and quickly responded by offering their own streaming service where their massive catalog offered them an obvious early advantage.
The rest, as they say, is history, leading to a chart since the beginning of 2015 that looks like this:
For a stock to gain over seven hundred percent in five years, actual results obviously must have to be spectacular, but those type of gains can only come if the market continually underestimates the stock’s potential. That has long been the case with Netflix. An early read of yesterday’s earnings suggested to many people that analysts had finally caught up with the company’s growth or, more worrying still, that growth had been maxed out.
Once again though, that market view assumes that this is the change that Netflix has failed to see coming, an assumption that is not borne out by the facts.
The U.S. media streaming market had to at some point become somewhat saturated, but there is strong evidence that Netflix, true to form, not only recognized that but began to prepare for it. International growth has been a priority for them for a while, and in that respect the numbers weren’t too bad. To be fair, it was still a miss, but nowhere near as bad percentage-wise as the domestic numbers. Netflix added 4.47 million international subscribers last quarter as compared to 670,000 domestic, so it is obvious where growth is coming from.
Netflix, it seems, is a victim of its own success. Expectations had gotten to unrealistically high levels, particularly for the domestic market and, after a long period of cautious predictions, the company started to buy into the hype and increase their own forecasts.
In that situation, a big short-term drop on a miss was coming at some point, but now that it is out of the way, NFLX is a buy again. The last time NFLX missed like this was in Q2 of 2016. On that occasion the stock also lost over thirteen percent, falling to below $85 before rocketing to $400. Traders and investors made a huge short-term mistake then by underestimating Netflix and they seem to have done so again.