Last night, after the market close, Netflix (NFLX) reported its Q4 2021 earnings, and its earnings per share (EPS) came in at $1.33, a big beat of the $0.82 that Wall Street analysts had expected, on revenue that was roughly in line with forecasts. Those are good results, and following their release, the stock did something that on the surface seems illogical on that kind of report -- it dropped.
I have often pointed out in these very pages that EPS and revenue numbers aren’t ever the be all and end all when it comes to a company’s earnings report. And that is definitely the case here. What caused the 20% or so drop in NFLX was not anything that happened last quarter, it was the company’s forecast for subscriber growth. The company said it expects to add only around 2.5 million new subscribers globally this quarter. That compares unfavorably to the 3.98 million it gained in Q1 2021 and makes a mockery of analysts’ expectations for around 6.9 million in Q1 2022.
To be fair, that isn’t really the analysts’ faults. They base their estimates off of what a company tells them, and Netflix had forecasted a much higher growth. Clearly, a lot of mistaken assumptions were made across the board, but they actually all come down to one basic thing, and it is that the thing that drove the stock to its high of just over $700 in November, as well as what has caused such a massive reaction overnight, is the assumption that whatever is happening right now will continue forever. Of course, we know that isn’t true, but that assumption frequently drives market moves all the same.
The questions going forward for investors, though, are is this another example of a market overreaction to current circumstances that will not stay the same, and will momentum therefore reverse? The answer is yes in both cases, but the reverse probably won’t come straight away
It is an overreaction because even though 2.5 million new subscribers is disappointing versus forecasts and expectations, it isn’t the end of the world. Netflix is still growing in what many consider to be a saturated market and making money while doing so. Given that, a trailing P/E of around 35, which it would be with NFLX at $400, doesn’t look to be excessive. That said, though, even though some kind of bounce back is possible today, there are reasons to hold off for a while before buying.
Firstly, as I said, the Wall Street forecast for Q1 subscriber additions was so far off because those numbers are largely based off the company’s own estimates. Now that those estimates are significantly lower, the analysts will be scrambling to adjust their estimates and price targets accordingly. That will cause some downgrades and headlines that, even though we know they are coming, will add to the pressure on the stock for a while.
Secondly, although adding 2.5 million subscribers in a quarter isn’t bad on a non-comparative basis, it adds to the current narrative that growth estimates are generally too high, and that any stock that derives much of its value from growth expectations should be punished. At some point that will change, but as long as it persists, there will probably be better entry points into a stock like NFLX to come.
While the 20% drop in NFLX after an earnings beat looks like an illogical overreaction in a purely numerical sense, it is actually quite logical given the immediate circumstances, the current sentiment and traders’ focus right now. However, all of those things will change before too long and when they do, Netflix will once again be looked at as what it is and has been for a while, a company with proven success and with massive free cash flow that can be used to produce content that will drive future growth.
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Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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