It's been a rough year to own consumer goods and technology stocks. Shares of Netflix (NFLX 0.89%) have been crushed, down 45% year to date. That performance trails the 19.6% decline in the Nasdaq Composite index.
But investors need to remember that Netflix is a business with revenue and profits and a valuable content library. The business is worth something.
Netflix is coming off a year where it posted double-digit revenue growth, and management's pivot to improving profitability and paying down debt is adding value to the company even if it's not immediately reflected in the stock price.
Here are three reasons Netflix is a great investment at these lower share prices.
Lowest valuation in years
A few years ago, the critics had an easier argument that Netflix might be overvalued. The company wasn't very profitable and was accumulating debt to finance its original content productions. But the story has shifted significantly in favor of the bulls over the last year.
Netflix has made a strong pivot to showing profitable growth. The result is that earnings per share nearly doubled to $11.24 in 2021. That has brought Netflix's price-to-earnings (P/E) ratio down to 29. This lower valuation has recently attracted the investment of at least one famous investor, Pershing Square's Bill Ackman, whose firm initiated a stake in Netflix earlier this year.
NFLX PE Ratio data by YCharts
Long-term growth potential is underestimated
Skeptics might point out Netflix's recent deceleration in subscriber growth, which dropped from an increase of 21.9% in the fourth quarter of 2020 all the way down to 8.9% in Q4 2021. Analysts currently expect revenue to grow 12.4% in 2022, with full-year earnings staying relatively flat near $11 per share. However, looking ahead to 2023, analysts expect earnings to reach over $14, which brings the stock's forward P/E down to an even cheaper multiple of 23.
Netflix has guided that operating profit margins will improve by a few points per year over any period of a few years. That should lead to growing earnings and a higher stock price over time.
Another way Netflix can grow profits is by raising prices, which the company has done several times over the last decade.
Netflix reported a 7% increase in average revenue per member in the fourth quarter, or two percentage points faster than the third quarter. Even with that increase, the $15.49 monthly price for a standard Netflix subscription is a bargain compared to cable, which can easily cost over $100 per month.
Image source: Getty Images.
While the growth of other streaming services could be to blame for Netflix's recent deceleration, no other streaming service can rival Netflix's breadth of content and easy-to-use interface across multiple devices. Digital TV Research expects Netflix to reach 275 million subscribers by 2026, which is still a minor portion of the expected 1.7 billion streaming video subscribers worldwide at that time.
Good capital allocation
With improving operating margin and free cash flow, management is planning to pay down its debt, reinvest in new experiences like gaming, and make selective acquisitions like recent deals to buy the Roald Dahl Story Company and Finnish game developer Next Games.
These are value-creating moves for shareholders. The stock may still hit new lows in the near term, but as the famous value investor Benjamin Graham said, "In the short run, the market is a voting machine, but in the long run it is a weighing machine." Netflix is trading at a much cheaper valuation that, considering the opportunities ahead, should lead to good returns for those who can withstand near-term volatility in the stock market.
