Markets

Why Netflix Stock Slumped Today

What happened

Investors were hitting the pause button on Netflix (NASDAQ: NFLX) today. After the stock rallied nearly 20% over the last three weeks in anticipation of the second-quarter report, the market gave the report a thumbs-down, sending the stock 6.8% lower as of 11:07 a.m. EDT.

So what

Overall, this was another strong quarter for the leading streamer, but a combination of high expectations and weak guidance seemed to douse the hot stock.

A TV showing the Netflix show "Luke Cage"

Image source: Netflix.

There's no question that the pandemic and the extra time at home that's resulted from it has been a tailwind for Netflix. It added 10.1 million subscribers in the quarter, its best-ever result for a second quarter and well ahead of its own guidance at 7.5 million. Revenue rose 24.9% to $6.15 billion, ahead of estimates at $6.08 billion, and operating profit nearly doubled in the quarter to $1.36 billion as operating margin expanded to 22.1% with profitability being aided by a cutback in production due to the pandemic. Free cash flow, a longtime bugaboo for the company, came at $899 million, up from negative $594 million last year, though the company expects to return to negative free cash flow next year.

Reported earnings per share was $1.59, below estimates at $1.81, but adjusting for $339 million in special expenses related to a deferred tax issue and a revaluation of its euro-denominated debt, EPS would have been about $2.31, well ahead of the consensus.

The company also said that longtime Chief Content Officer Ted Sarandos would join Reed Hastings as co-CEO.

Now what

What really seemed to push the stock lower was guidance for the third quarter, which called for subscriber additions of just 2.5 million, below the 6.8 million it added in the third quarter last year. In the shareholder letter, management explained: "In Q1 and Q2, we saw significant pull-forward of our underlying adoption leading to huge growth in the first half of this year (26 million paid net adds vs. prior year of 12 million). As a result, we expect less growth for the second half of 2020 compared to the prior year."

A chart in the letter showed subscribers actually declined slightly in June, though that may be because the company booted a number of lapsed subscribers off the service in the interest in of fairness, as it assumes they're no longer interested in paying for Netflix.

Though the third-quarter guidance was disappointing, investors shouldn't take it as gospel. There's a whole lot of uncertainty ahead around the COVID-19 pandemic, especially as a resurgence of cases in the U.S. could lift subscriptions in its biggest market. Management is likely being conservative, given the record performance in the first half of the year.

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Jeremy Bowman owns shares of Netflix. The Motley Fool owns shares of and recommends Netflix. 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.

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