Netflix Earnings – NFLX Needs Global Growth, Lower Costs

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Netflix (NFLX) is outperforming the market yet again in 2014, with shares of NFLX stock up about 20% on the year compared to roughly 3% for the S&P 500 index since January 1.

nflx netflix stockBut despite its success, Netflix stock remains one of those players that many on Wall Street love to hate.

NFLX still boasts a high forward price-to-earnings ratio of almost 70, it’s still plowing big money into overseas expansion despite a lack of real profits there yet, and there is ever-increasing competition in the streaming space from the likes of Amazon (AMZN) with its Prime Instant Video, Hulu Plus, HBO Go and other options.

Unfortunately, after the big run in the last few years, Netflix is a victim of its own success — and NFLX investors should tread lightly with the stock at this level, because there could be some pain ahead if earnings miss the mark.

NFLX Stock — Watch International Growth and Content Costs

Part of the reason for a high P/E ratio right now for Netflix is the continued investment in new content and international growth. NFLX stock reports that total revenues in its International Streaming segment have soared, from $43 million in the first quarter of 2012 to more than $307 million as of last quarter.

However, the cost of revenue and marketing both have soared in kind, and Netflix recorded a small $15 million loss on its international operations last quarter. Netflix badly needs to move into the black abroad.

Also, it’s important to note that the cost of content for Netflix continues to rise. The “Cost of Revenue” line in Netflix’s segment breakdown almost wholly accounts for content licensing … and that figure has soared over the last few years. Take a look:

Netflix Results for Q2 2012

Total streaming, cost of revenues — $491 million
Total members — 27.6 million

Netflix Results for Q2 2013

Total streaming, cost of revenues — $836 million (up 70% over previous year)
Total members — 37.5 million (up 35%)

Netflix Results for Q2 2014

Total streaming, cost of revenues — $1.1 billion (up 36% over previous year)
Total members — 50 million (up 33%)

The bottom line is that the cost of revenue is growing faster than the subscriber base. This trend needs to mitigate if Netflix is going to significantly grow its profits and reduce its sky-high price-to-earnings ratio.

Now, it’s worth noting that NFLX has taken some big strides to cut costs — notably by venturing into original programming that, on the whole, costs less for the streaming video giant to serve up to its customers.

It’s also noteworthy that Netflix raised prices early in 2014 for new subscribers, with little impact on growth or backlash from consumers. That will obviously help margins — and future increases in price could do the same.

But regarding the October Netflix earnings report and what’s next for NFLX, the company will live and die based on how it is keeping down its content costs and how it is growing overseas.

If these metrics don’t look good … it could be painful for Netflix stock.

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Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP


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