Understanding the Growth Potential for Netflix, Inc.

With Netflix stock seemingly hitting new highs every day, soaring about 85% in the past six months alone, it's a good time to take a look at the company's underlying business. Getting a better understanding of the potential for Netflix's business to grow in the future can help investors see whether or not the stock is getting ahead of itself or not.

Looking at Netflix's U.S. market

Most important to Netflix's business today, of course, is the company's U.S. streaming business. Forty-two of its 65 million members are based in the U.S. Likewise, more than half of its revenue comes from the U.S.

What sort of growth is Netflix's U.S. market poised to serve up? Given management's targets for 60 million to 90 million customers in the U.S. by 2020, as well as plans to average a 5% annual increase in prices, the company's U.S. annual revenue in 2020 could be around $8.1 billion -- or about triple the market's current annualized revenue run rate of $4.1 billion. Not bad.

But here's where the real growth comes in: Netflix also plans to be more profitable by 2020. "The US contribution margin structure we have chosen is to grow content spending plus marketing slightly slower than we grow revenue, increasing our contribution margin to 40% by 2020," management explained in its Long-Term View letter on its website.

This contribution margin target is well ahead of the company's 17% contribution margin today. A rapidly improving contribution margin will leverage the impact of Netflix's rising revenue on its contribution profit.

Applying a 40% contribution margin to an estimated $8.1 billion in annual revenue from its U.S. market by 2020, Netflix's annualized contribution profit would be about $3.2 billion. This figure handily eclipses Netflix's annualized gross profit run rate of $1.4 billion today.

So far, the company's goal for a contribution margin for its U.S. business of 40% by 2020 is looking realistic. Thanks to the company's stronger-than-expected revenue and lower-than-expected content and other streaming costs, Netflix is actually ahead of schedule. It's possible that the company could eventually raise its contribution margin target even higher.

Add in international markets

Once you mix in international markets, there's plenty more opportunity for growth in Netflix's underlying business. Its contribution margin in most of its international markets likely won't be at 40% in 2020, but Netflix won't need its international contribution margin to equal its domestic margin for the segment to begin contributing meaningfully to its business.

With plans next year to expand to China, as well as nearly every country on earth, it's likely that Netflix's total international revenue will be well ahead of its U.S. revenue by 2020. A smaller contribution margin on higher revenue, therefore, could mean that Netflix's international contribution profit would rival its U.S. contribution profit.

Assuming Netflix's total contribution profit from international revenue comes close to its U.S. contribution profit by 2020, and also forecasting approximately two-thirds of this contribution profit to make it to the company's bottom line, the company's market capitalization of $53.4 billion today begins to sound somewhat reasonable. Essentially, these forecasts would mean Netflix is currently trading at 12.4 times a 2025 annual earnings estimate.

While this exercise is too simple to count as a full-out buy, sell, or hold analysis, it at least shows that there's some reason behind the stock's bullish valuation.

3 Companies Poised to Explode When Cable Dies

Cable is dying. And there are 3 stocks that are poised to explode when this faltering $2.2 trillion industry finally bites the dust. Just like newspaper publishers, telephone utilities, stockbrokers, record companies, bookstores, travel agencies, and big box retailers did when the Internet swept away their business models. And when cable falters, you don't want to miss out on these 3 companies that are positioned to benefit. Click here for their names. Hint: They'renot the ones you'd think!

The article Understanding the Growth Potential for Netflix, Inc. originally appeared on Fool.com.

Daniel Sparks has no position in any stocks mentioned. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

Copyright © 1995 - 2015 The Motley Fool, LLC. All rights reserved. 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.