Is It Too Late to Buy Netflix Stock?

Netflix's (NFLX -1.38%) stock price dropped 8% on July 20 after the streaming video leader posted its second-quarter results. Its revenue rose 2.7% year over year to $8.19 billion but missed analysts' estimates by $100 million. Its net income grew 3% to $1.49 billion, or $3.29 per share, and beat the consensus forecast by $0.44.

Its paid subscribers grew 3% sequentially and 8% year over year to 239 billion. All of those growth numbers seemed stable, but investors were likely looking for even higher numbers to justify the stock's year-to-date gain of more than 60% prior to its earnings report.

So is it too late to buy Netflix's stock after its post-earnings decline?

Image source: Getty Images.

Review Netflix's key growth rates

A year ago, Netflix suffered its first sequential loss of subscribers in more than a decade. That decline -- which it attributed to the Ukrainian war, competitive headwinds, and the post-pandemic slowdown of the streaming video market -- rattled the bulls and raised red flags for its future. But since reaching that trough, its subscriber base has steadily grown over the past year.

Data source: Netflix. YOY = Year over year.

However, a lot of that growth was driven by new subscribers in overseas markets, many of whom pay lower subscription fees than its higher-revenue subscribers in the U.S. and Canada. That higher mix of lower average revenue per member (ARM) markets caused its quarterly revenue to decline sequentially throughout most of 2022 -- but its sequential growth turned positive again over the past two quarters.

For the third quarter, Netflix expects its revenue to rise 7.5% year over year (and 4% sequentially) to $8.52 billion. Unfortunately, that guidance fell short of the consensus forecast of $8.68 billion -- which suggests its new ad-supported tier and paid accounting sharing plans aren't generating nearly as much revenue as the bulls had expected.

Yet in its shareholder letter, Netflix said it still expects its "revenue growth to accelerate in the second half of [2023] as we start to see the full benefits of paid sharing" along with the "steady growth in our ad-supported plan." It said it had already launched its paid sharing plans in more than 100 countries which accounted for over 80% of its revenue base, and that its ad-tier membership had "nearly doubled since Q1." It also gradually phasing out its basic ads-free plan in several markets (starting with Canada, and moving on to the U.S. and U.K.) for new and rejoining members as it expands its ad-supported tier.

Netflix's operating margins are also rising as its revenue growth stabilizes, the dollar weakens, it reins in its spending, and it expands its higher-margin advertising business. Its operating margin grew 250 basis points year over year and 130 basis points sequentially to 22.3% in the second quarter, and it reiterated its full-year target for an operating margin of 18%-20% -- up from 18% in 2022. It also lifted its full-year free cash flow (FCF) forecast from $3.5 billion to "at least" $5 billion.

But that higher FCF forecast isn't necessarily good news for Netflix, since it's attributed to the ongoing WGA and SAG-AFTRA strikes which halted its production of new content. A prolonged Hollywood strike might drive more people to Netflix and other streaming services as new theatrical films and shows are delayed, but it could also deprive its own platform of fresh content. It could also be forced to pay out higher licensing fees, royalties, and residuals if new deals are struck to end the strikes.

Netflix's stock is still pricey relative to its growth

For many years, Netflix was valued as a high-tech stock alongside its FAANG peers instead of a traditional media company. But as its growth cools off and the streaming market matures, its valuations could be compressed to match traditional media companies like Disney and Paramount Global.

Analysts currently expect Netflix's revenue and earnings to grow 8% and 13%, respectively, this year. Disney's revenue and earnings are expected to both improve by about 7% in fiscal 2023 (which ends in September). Paramount's revenue is expected to rise just 1% this year as its earnings tumble 65%.

Netflix has a big advantage against Disney, Paramount, and other legacy media companies: it generates consistent profits from its streaming platform, thanks to its scale and years of investments, while they're all racking up steep losses to catch up.

But if Netflix loses that advantage, investors will quickly notice that its stock isn't cheap at 39 times forward earnings. By comparison, Disney and Paramount have forward multiples of 16 and 28, respectively. So while it might not be too late to buy Netflix as a long-term investment, I don't think investors should rush to pull the trigger until its valuations cool off.