Personal Finance

Is Netflix Inc. a Growth Stock or a Cult Stock?

I personally like to invest in growth stocks, but Netflix (NASDAQ: NFLX) has always seemed too hot to handle. The stock's valuations never seem justified by its earnings, yet it's rallied almost 900% over the past five years.

The bulls usually call Netflix a "growth" stock, while many bears call it a "cult" stock supported by brand awareness instead of fundamental growth. Let's take a closer look at the streaming giant's growth figures to see which label is better suited for the streaming video leader.

Image source: Netflix.

How fast is Netflix growing?

Between fiscal 2011 and 2016, Netflix's annual revenues rose 175% from $3.2 billion to $8.8 billion. During those five years, its total streaming subscribers worldwide climbed from 23.5 million to 93.8 million as it pivoted away from DVD-by-mail subscriptions and expanded to overseas markets.

Last quarter, Netflix's total subscriber base grew 25% annually, fueled by 10% growth in the U.S. and 48% growth overseas. That growth silenced critics who claimed that Netflix's gradual increases in fees would cause its subscriber growth to peter out. The bulls will likely claim that Netflix's robust revenue and subscriber growth supports its price-to-sales ratio of 6.8 -- which is more than double the industry average of 3.3 for broadcast media companies.

Those numbers clearly indicate that Netflix's ecosystem is growing, and explain why it's become synonymous with streaming video in many markets. That's why analysts expect Netflix's revenue to rise 27% this year and another 20% next year. Meanwhile, Netflix's growing portfolio of acclaimed original shows -- like House of Cards , Daredevil , and Stranger Things -- are locking in subscribers and reducing its dependence on pricey third-party content.

But what about the bottom line?

Netflix's revenue and subscriber growth look solid, but its bottom line growth doesn't. Between 2011 and 2016, Netflix's net income actually fell 17% from $226.1 million to $186.7 million due to the rising costs of licensing third-party content, the development of its own multi-million dollar programs, and its aggressive expansion into overseas markets with localized content.

Image source: Netflix.

But on the bright side, Netflix's operating margin has improved over the past few quarters, rising from 3.3% to 6.2% between the fourth quarters of 2015 and 2016. Netflix sees higher revenue growth and reduced expenses boosting that figure to 9.1% for the current quarter. Based on these bottom line improvements, Netflix's net earnings are expected to grow 158% this year and 82% next year.

Those figures sound impressive, but they don't really justify the stock's trailing P/E of 379. Its forward P/E of 69 looks less frothy, but it still indicates that quite a bit of its future growth is already priced in. Investors should also note that Netflix's heavy spending dropped its free cash flow to negative $639 million at the end of the fourth quarter, compared to negative $276 million in the year ago quarter.

Mind the disruptive headwinds

Netflix has been a disruptive force over the past decade, first crushing movie rental giants like Blockbuster and then skewering traditional media, cable, and advertising companies by convincing their subscribers to "cut their cords."

But looking ahead, Netflix is headed for head-on collisions with Time Warner 's(NYSE: TWX) HBO, Amazon 's(NASDAQ: AMZN) Prime Video, and numerous other stand-alone over-the-top (OTT) platforms. If AT&T (NYSE: T) is cleared to buy Time Warner, the telecom giant could exclude HBO Now and other streaming content from data charges across its networks -- which could force Netflix to subsidize its users' data costs or pay AT&T for "zero-rated" content.

Meanwhile, Amazon has aggressively expanded Prime Video with original content to counter Netflix, bundled the platform into its prisoner-taking Prime memberships, and even offered stand-alone video subscriptions at lower prices than Netflix. Amazon Video has already become the third largest streaming video service in North America after Netflix and YouTube according to research firm Sandvine -- so it's certainly well-poised to hurt the streaming leader.

So is Netflix a growth stock or a cult stock?

I used to consider Netflix a cult stock, but I don't think the label is accurate anymore considering the stability of its subscriber and revenue growth and its improving margins. Netflix still looks pricey relative to its trailing 12 month earnings, but its stabilizing bottom line growth indicates that it's not that expensive relative to its future earnings growth potential.

Netflix is certainly a risky stock, and competitive moves by Time Warner, AT&T, and Amazon could sink it. But it's still a growth play which could rally even higher as it locks in even more users worldwide with well-received original shows and movies.

Find out why Netflixis one of the 10 best stocks to buy now

Motley Fool co-founders Tom and David Gardner have spent more than a decade beating the market. (In fact, the newsletter they run, Motley Fool Stock Advisor, has tripled the market!*)

Tom and David just revealed their ten top stock picks for investors to buy right now. Netflix is on the list -- but there are nine others you may be overlooking.

Click here to get access to the full list!

*Stock Advisor returns as of January 4, 2017

Leo Sun owns shares of and AT and T. The Motley Fool owns shares of and recommends and Netflix. The Motley Fool recommends Time Warner. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

In This Story


Other Topics


Latest Personal Finance Videos

The Motley Fool

Founded in 1993 in Alexandria, VA., by brothers David and Tom Gardner, The Motley Fool is a multimedia financial-services company dedicated to building the world's greatest investment community. Reaching millions of people each month through its website, books, newspaper column, radio show, television appearances, and subscription newsletter services, The Motley Fool champions shareholder values and advocates tirelessly for the individual investor. The company's name was taken from Shakespeare, whose wise fools both instructed and amused, and could speak the truth to the king -- without getting their heads lopped off.

Learn More