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Complete Netflix Stock Analysis and When to Buy

Invest now for a quick bounce in Netflix stock price or wait for a long-term buy?

Shares of Netflix plunged 10% after its last quarter earnings and the company is about to face its biggest competition yet for streaming.

In this video, I’m doing a complete analysis on the stock price, why I think shares could rebound 25% but why you still might not want to invest.

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netflix stock price analysis

My Conflicted View on Shares of Netflix

To be honest, I’ve always had a love-hate perspective on Netflix. On the one hand, the company is an undisputed leader and a pioneer in streaming. Netflix was streaming before streaming was THE thing and it’s reinvented entertainment.

And the return on Netflix stock has been unbeatable. In fact, none of the other FANG stocks; that’s Facebook, Apple and Google, none of them even come close to matching the 420% return on Netflix over the last five years.

But as a value and dividend investor, I’ve always been skeptical of Netflix as an investment. Even after the big selloff last month, shares are priced at 122-times the company’s earnings. Compare that against a PE ratio of just 16 for Disney or an average around 18-times for peers in the entertainment space.

So investors are saying future earnings out of Netflix are worth 7-times Disney’s future earnings. While Disney just produced the top grossing film of all time!  

And while Netflix has continued to grow revenue, it spends more than three-quarters on the content.

This is something we’ll look into more because it’s the single biggest issue for Netflix but the cash it burns to produce content leaves little left for profits. The company spent over $13 billion last year just producing content, more than 82% of the $15.8 billion it made for the year.

Netflix Analysis of Expenses
Netflix Analysis of Expenses

The trend in that spending is increasing and as an investor, you have to wonder if it will ever be able to get those production costs down.

It’s hard to argue against the success in shares though and the 15% selloff after last quarter’s earnings may be enough to get even a skeptic like me into the stock.

Analysis of Netflix Stock Price

So let’s work through a Netflix stock analysis. I’ll cover expectations on earnings, the biggest factors driving the stock price and we’ll look at analyst estimates over the next year.

Looking back at the company’s price-to-earnings ratio and we see something typical for a growth stock. A ridiculously high PE ratio that is slowly trending down over the years, here around 200-times earnings in 2017, touching a low around 100-times late last year but around a 150-multiple for most of the year.

And this is the big hang-up for investors in growth stocks, how do you justify paying 100-plus times a company’s earnings when you can get a competitor’s shares for a fraction the valuation?

If you do invest, you’ve got another problem with growth stocks.

The Problem with Growth Stocks like Netflix

That PE ratio is going to trend towards the industry average over time. A company can’t double sales every year or it would be bigger than the economy in short order, so as growth slows, investors start paying less for future earnings.

We saw with Netflix that investors were paying upwards of 300-times earnings in 2016 but are now only willing to pay half that. So you need the confidence that, in the future, even if investors aren’t willing to pay that sky-high price-to-earnings multiple, that earnings will have increased enough that you can still make money when you sell the stock.

It makes my job as an analyst a hell of a lot harder as well.

I can estimate a company’s sales and earnings out a year or two but knowing how much investors are going to be willing to pay is almost impossible. Will that PE ratio still be at 150-times earnings or is maybe 75-times earnings a better benchmark? I need to know that to make a target price on my earnings forecast.

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Netflix Earnings and Sales Expectations

We see here that analysts are expecting Netflix to report earnings of $4.80 a share over the next four quarters. That’s an increase of 88% over the $2.55 per share reported over the last four quarters and there’s a good chance they’ll meet or beat those expectations. Even in this most recent quarter where subscriber additions disappointed, the company beat earnings estimates.

Netflix Earnings Analysis
Netflix Earnings Analysis

Sales are expected just 28% higher to $22.6 billion over the next four quarters and this is where we start to see a problem in the numbers.

If Wall Street expects Netflix to grow earnings by 88% but to only make 28% more in revenue, it’s saying the company will become a lot more profitable. In fact, to get these numbers to work out, Netflix has to go from a profit margin of 6% to 9% in one year…which would be a huge accomplishment when you’re also trying keep that pace of growth.

Major Factors in Netflix Shares

But let’s look into some of the recent headlines and the business to see if we think the company can reach those numbers and what a fair price for the stock would be.

Probably the biggest metric for Netflix is Net Adds, the increase in paid subscribers the company reports each quarter. You can take a fairly even average revenue per user against this and get a good idea of how much the company is going to make in any give quarter.

And that was the big bad news when the company reported second-quarter numbers last month. Netflix reported adding just 2.7 million subscribers versus expectations that it would add five million subscribers. Not only did the company miss expectations but the subscriber adds for the quarter were way below the previous quarter. International subscriber adds hadn’t been so low for three years and the company actually lost 100,000 subscribers in the United States.

Shares were already off recent highs but plunged 10% on the news and are now down 18% off the 52-week high.

But take a look at this graphic put out by the company and you’ll start to see why I think we could be in for at least a short-term bounce in the shares. What we’re looking at here is the forecasted net adds, the grey triangles, and the actual reported adds in green or red for each of the last 14 quarters.

Netflix Subscriber Analysis
Netflix Subscriber Analysis

Netflix has missed that forecasted number once a year in each of the last three, only to turn around and beat the forecasts in the next few quarters. The second quarter of the year is usually weak on content, in fact you see that three of the four misses here were in the second quarter and management pointed to that weak slate of new releases in the quarter.

The third season of Stranger Things released in the third quarter and the second half includes some major exclusives from heavy-hitters like Martin Scorcese, Michael Bay and the final season of Orange is the New Black which could be a huge draw.

The one bright spot in the second quarter was that even as subscriber adds missed forecasts by more than two million subs, the company still managed to meet expectations for revenue and earnings. It did this on a 10% increase in prices so while the company didn’t add as many subscribers, it was able to make more on existing customers to offset the difference.

What I think you see over the rest of the year, and we’ll get to my specific price target later, is subscriber growth coming back in the last two quarters plus that higher price point which should help the company report blockbuster sales and earnings.

Now that’s great for short-term investors that can bag a solid return over the rest of the year but the picture changes for longer-term investors.

Netflix Competition in Streaming

Over the next twelve months; Disney, Apple, WarnerMedia and NBC all launch their streaming channels. Right now, Netflix has a commanding share of global video streaming traffic but how does that change when goliaths like Disney and Apple get in the game?

Apple is spending a billion dollars on initial programming including signing stars like Jennifer Aniston, Steve Carrel and Captain America himself Chris Evans. Of course, the big question mark is how much damage Disney will do with its $7 a month service and a lineup of original content on top of a massive library of films. Netflix has already released that it’ll be losing two of its most popular shows, The Office, and, Friends, to other streaming services later in the year.

Now if we dig back into the numbers, and I know this gets complicated but it’s really the depth of analysis you need to do if you’re going to be investing in individual stocks. So Netflix booked just over $270 million in profits last quarter on $4.9 billion in revenue. That means the company converted 5.5% of its sales into earnings after all these expenses.

That top-line revenue number is growing but its already seeing slowing subscriber growth and competition from other streaming services is going to make those price increases much harder to push through in the future.

So meeting those big expectations in earnings growth needs to come down to profitability. That profit margin of 5.5% needs to come up closer to something like Disney’s that converts 21% of its revenue into earnings.

That could be extremely difficult considering how much Netflix pays for content alone, then you’ve got all the marketing and other costs as well.

Analyst Targets for Netflix Stock Price

Let’s put all this together though and look at some analyst price targets. First though, if you’re liking the video, do me a favor and tap that thumbs up button below.

More than 30 analysts cover shares of Netflix with estimates ranging from $515 a share by Jeffrey Wlodarczak of Pivotal Research, that’s a 65% upside to the current price, to Michael Pachter at Wedbush with a low target of $188 per share and a 39% downside.

Despite that low target, most of the analysts are grouped right around a $400 per share target so a 26% upside to the stock.

For my part, I do think shares can rebound over the rest of the year. The company has a strong lineup and we still have a few months before competition really heats up. Netflix is making a strong push into India with a mobile-only service and I think subscriber adds for the rest of the year could really surprise to the upside.

If you do decide to invest in shares of Netflix, use the free investing platform I use, M1 Finance. You’ll save thousands in fees and get everything you need to grow your portfolio.

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