It hasn’t been a good week for Netflix, Inc. (NASDAQ:NFLX), nor has it been a good year. Among the so-called “FANG” stocks — Facebook Inc (NASDAQ:FB), Amazon.com, Inc. (NASDAQ:AMZN) and Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) — NFLX is the definitive black sheep.
While the other three combine for an average year-to-date performance of 12%, Netflix stock is down an eye-popping 15%. Can this otherwise fan-favorite prove the critics wrong?
At first glance, the bullish argument doesn’t look too hot. Over the past month, NFLX stock has given up 3% of its market value despite a massive earnings beat for its second quarter of fiscal year 2016.
Adding insult to injury, a spokesperson for Alibaba Group Holding Ltd (NYSE:BABA) shut down rumors that NFLX and the Chinese e-commerce titan were in talks for a business deal. As a result, Netflix stock dropped 2% earlier this week.
The seeming lack of progress toward the Chinese market is a major drag. The biggest reason NFLX sold off harshly after its Q2 results was a sharp decline in subscriber growth. In fact, the actual haul in new subs was 15% worse than a previously downgraded company forecast. That was more than enough for the faithful, but the inability to rectify that gaping wound with a China deal is sure to cause more fret over what to do with Netflix stock.
There’s no denying that the streaming content provider is in quite a pickle. At the same time, I think the subscriber issue is a scapegoat rather than the catalyst for the NFLX underperformance. To paraphrase InvestorPlace executive editor Jeff Reeves, there’s only so many people in the world that have adequate internet service. At some point, NFLX will no longer be able to gain new subs at their previously exponential rate. That’s just life.
Contrarian Argument for NFLX
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Annual returns for NFLX stock are highly correlated to growth in the bottom line, not the top. The correlation coefficient for the former is 0.6, whereas revenue and investor returns — at a coefficient of -0.18 — have no meaningful relationship.
That’s the reason why subscription growth and top-line sales hit all-time highs last year, yet did not produce a record year for NFLX investors. But in 2013, both earnings growth and annual market returns soared to unprecedented heights, while producing modest gains in sales.
I’m not going to go so far as to say subs don’t matter — they clearly do. What I want to suggest is to place the drivers for NFLX stock in their proper context. For that, John Landgraf, president of cable television channel FX, had the perfect insight when he expressed concerns about Netflix’s overproduction of original shows.
Landgraf stated, “You could give me all the money in the world and I couldn’t supervise 71 shows the way I do ours.”
Netflix Stock: Down, but Not Out
The issue with NFLX stock isn’t so much the challenges of breaking into a new market, or aggressive competitor activity. These are realities that affect all upwardly charging businesses, and are mostly outside of management’s control. Rather, NFLX and its shareholders must accept that they are no longer in their prime growth phase. As they enter the mature end of the S-curve, management has two choices — make more money per sub, or create another revolutionary product.
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Between 2006 and 2009, NFLX stock averaged $4.31. From 2010 through 2012, the average price jumped 335% to $18.72. Since then, we’ve never seen magnitude like that, and it’s unlikely we ever will.
This year has admittedly provided plenty of ammunition for the “Never Netflix” crowd. Certainly, the competitive landscape and declining subscription growth are huge concerns that will weigh on NFLX stock. Yet it’s a little too much to dump a company for running into problems that are part and parcel of any industry.
Netflix stock won’t give you the crazy returns it once provided. But talks of cancellation are premature.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
