The idea that Wall Street massively overreacts to short-term data certainly isn’t new. But the Street’s decimation of Netflix (NASDAQ:) stock over the company’s second-quarter subscription miss shows that the phenomenon is alive and well. Since NFLX reported the miss on July 18, Netflix stock has tumbled nearly 25%.
As I mentioned in a the tremendous hit that NFLX stock has taken feels very similar to the huge clubbing that Snap (NYSE:) took after its user base declined for a few quarters year-over-year.
In the case of Snap stock, most of the Street decided that Snap’s small year-over-year user growth declines trumped every strength and opportunity the company had. As a result, the shares tumbled from over $17 in February 2018 to around $5.50 in December 2018.
In several columns that were published during the collapse of Snap stock, I pointed out the company’s opportunities and strengths that investors were ignoring. By using its strengths and exploiting those opportunities, Snap was able to improve its results, causing Snap stock to climb tremendously. Snap stock now changes hands for almost $16 per share.
Similarly, the Street is now largely ignoring Netflix’s strengths and opportunities. The company’s key strengths are its ability to consistently develop hit TV dramas that appeal to a wide swath of American adults and the continuous, rapid growth of its overseas business.
As far as opportunities, Netflix’s potential market is large enough to enable it to become profitable. Additionally, Netflix stock should be boosted from its status as the best-positioned FAANG — Facebook (NASDAQ:), Apple (NASDAQ:), Amazon (NASDAQ:), Netflix and Alphabet (NASDAQ:, NASDAQ:GOOGL) — stock. I know that statement will be totally shocking to many, but I love contrarian thinking and I’ve noticed that it’s often correct.
Let’s look at each of these points in detail.
Netflix Has an Edge in Churning Out Adult Drama Hits
From “House of Cards” to “Stranger Things” to “Orange is the New Black” to “Ozark” to “The Crown,” Netflix has show the ability to churn out hit, original dramatic TV shows fairly consistently.
Its looming competitors do not have a comparable record. Apple has no experience with producing TV shows. In the current decade, Disney’s (NYSE:) ABC network launched two shows, “Scandal” and “Blackish,” that were arguably hits. It’s true that two shows launched by ABC in 2009, “Modern Family” and “Shark Tank,” turned into big hits.
Still, it’s clear that Netflix has the edge over ABC, and, by extension, Disney, when it comes to producing hit dramas. Furthermore, the networks that make up AT&T’s (NYSE:) WarnerMedia, which will also compete with Netflix, developed one original hit show since 2010 … “Game of Thrones.”
Additionally, as I last month,
The price points of the streaming video services should allow a majority of Americans to afford more than one streaming service. Disney+ will only cost $6.99 per month. AAPL hasn’t announced the price of Apple TV+, but it’s expected to be well below the $13 cost of a standard Netflix plan.
Netflix’s Overseas Business Is Still Growing Rapidly
In Q2, NFLX added a net total of 2.83 million international subscribers. Although that came in below the average estimate of 4.8 million cited by, a 2.8 million increase is quite impressive. Additionally, the company’s overall streaming paid memberships surged nearly 22% to $151.5 million.
So although Netflix’s U.S. net subscriber total contracted a (relatively tiny) 126,000 year-over-year, the company is clearly still growing rapidly overall.
The Data Shows That Netflix Stock Can Be Extremely Profitable
In my previous column on Netflix stock, I noted that if Netflix becomes twice as popular as Apple around the world, Netflix’s revenue could reach around $72 billion per year.
InvestorPlace contributor reported last week that NFLX was expected to spend more than $15 billion on content this year. In the six months that ended in June, Netflix’s net income, which excludes its content spending, came in at nearly $1.3 billion, on revenue of $17 billion. That equates to an annual profit, excluding content spending, of about $2.5 billion on a top line of $34 billion. So if Netflix spends $15.5 billion on content, its total cash flow will be -$13 billion.
Let’s assume, however, that NFLX reaches my revenue target of $72 billion in five years. Let’s also assume that its spending on areas other than content comes in at $20 billion (it spent roughly $8 billion on those items in the first half of this year) and that its annual spending on content remains $15.5 billion.
In that case, in five years, it will have a huge positive cash flow of around $35 billion. (I calculated that total by subtracting its estimated content and non-content spending from the $72 billion figure).
Apple stock currently trades at about 13 times its trailing 12 month cash flow. Multiplying Netflix’s estimated 2024 cash flow of $35 billion by that 13 multiple yields a market cap of $455 billion. That’s nearly triple the current market cap of Netflix stock of $127.6 billion.
NFLX Stock Is in a Better Position Than the Other FAANG Names
The Street has paid a great deal of attention to Netflix’s looming competition. But as we’ve shown above, none of the company’s upcoming competitors has had much success making original shows in recent years. Furthermore, Netflix is actually poised to benefit from the tremendous acceleration of cord-cutting that that the new competitors will bring about.
Conversely, Facebook, Apple, Amazon and Alphabet’s Google are all facing tougher competition, from Snap, Chinese smartphone makers, huge retailers and Amazon’s ads, respectively. But in the U.S. and to a great extent globally, nobody expects that increased competition to greatly enlarge the markets in which those companies dominate. That’s because those markets (social media for Facebook, smartphones for Apple, e-commerce for Amazon and internet search for Google), are all largely saturated.
Additionally and importantly, it is widely believed that all of the FAANG stocks except Netflix are being probed by the . Therefore, only by purchasing Netflix stock can investors buy a FAANG name that definitely won’t have its wings clipped by the government.
As the Street internalizes these realities, a great deal of money will go into Netflix stock.
The Bottom Line on Netflix Stock
The year-over-year decline in Netflix’s U.S.subscriber base may have occurred for many reasons last quarter. The company’s price increases and its relative lack of new content likely played a role, as NFLX stated. Hype over the upcoming offerings from Disney and Apple could also have stunted the company’s growth. Even weather in parts of the U.S. could have had an impact, as some Americans decided to spend less money on TV and more on outdoor activities.
In the longer run the powerful strengths and opportunities of Netflix stock will be much more important than one quarterly data point.
As of this writing, Larry Ramer did not own shares of any of the aforementioned securities.
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