The high-growth and technology stocks market has been brutal over the past few months. With fourth-quarter earnings reports coming out in January and February, many stocks were hit with sharp drawdowns after putting out results that were disappointing for investors who are worried about the Federal Reserve raising interest rates and the Russian invasion of Ukraine. Premium video streamer Netflix (NFLX -1.38%) was one of these companies. Netflix's stock fell 20% the day following its earnings report in late January and is now down a whopping 40% year to date. Price drops like these can be stomach-turning, but they can sometimes provide fantastic buying opportunities for investors focused on the long term.
Is Netflix stock a buy right now? Let's take a look.
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Solid Q4 report, but weak guidance
On Jan. 20, Netflix reported its earnings for the last three months of 2021. Revenue and subscriber numbers were right in line with what Netflix and investors expected. Revenue grew 16% year over year to $7.7 billion, and subscribers grew 9% to 222 million around the world. Revenue growth is outpacing subscriber growth because of the price increases Netflix has implemented, specifically in the United States and Canada (UCAN) region. The average revenue per account was $14.78 in UCAN last quarter, up 9% year over year.
The one negative from the earnings report, and likely the big reason the stock dipped so much in the following days, was subscriber guidance for the first quarter of 2022. Management expects to add 2.5 million subscribers in Q1, significantly less than Wall Street's expectation of 7 million subscribers. This modest projection isn't necessarily a huge negative, but it is much lower than Netflix's historical subscriber growth numbers. If this trend continues, it will lead to lower revenue growth over the next few years.
Netflix has also been hurt by the broad market sell-off that has come from fears of interest rate increases and the Russian invasion of Ukraine. The Nasdaq 100 Index is down over 15% this year, which has exacerbated Netflix's sell-off after its weak forward guidance.
Where future growth can come from
With 222 million subscribers worldwide (and many more people using the service through shared accounts), many investors are likely asking how much Netflix can grow its subscriber base over the next decade. Of course, this growth will lead directly to revenue and hopefully profit and cash flow growth as well, so it is the biggest question investors need to consider before investing in Netflix.
Growth will likely not come from UCAN outside of price increases. With 75 million active accounts (remember, a lot are shared between family and friends) in the region, there just aren't that many people left to subscribe to the service. This leaves the Europe, Middle East, and Africa (74 million current subscribers), Latin America (40 million current subscribers), and Asia Pacific (32.6 million current subscribers) regions to drive user growth over the next decade. Netflix is investing heavily in local content for all these regions, which can hopefully keep subscribers growing steadily over the next three to five years. With all three areas having larger populations than UCAN, subscriber numbers should eventually pass Netflix's home market, albeit with lower-priced subscriptions in many countries.
Valuation has gotten a lot more reasonable
Netflix's current market cap is $159 billion. Add on $15 billion in debt and subtract out $6 billion in cash, and it has an enterprise value of $165 billion. With $6.2 billion in operating income in 2021, that gives the stock a trailing enterprise value-to-operating-income of 26.6, right around the market average. If Netflix can continue growing its top line while also gaining operating leverage, investors should expect this earnings multiple to come down over the next few years.
One potential problem investors should watch is the conversion of operating income into free cash flow (FCF). In 2021, Netflix had a negative $158 million in FCF. The divide between operating income and FCF comes from the fact that Netflix is still investing heavily in content all around the world to grow its subscribers and the value of the Netflix service. This strategy is fine in the short run, but investors need to expect FCF and operating income to converge for Netflix stock to be a strong investment over the long term.
So is Netflix a buy?
Given the stock's reasonable earnings multiple, I think Netflix can be a buy here if you believe subscriber growth will continue to grow internationally and that FCF will eventually converge with operating income. If and when this happens, Netflix will continue growing revenue at 10%+ a year with steadily rising cash flows. In the long run, stock price returns will consolidate around this financial growth.
