You saw that one coming, right?
Wall Street favorite and tech powerhouse Netflix (NASDAQ:NFLX) saw its stock drop as much as 15% after the company added fewer subscribers than expected in the second quarter. But, since opening at $340, NFLX stock has come roaring back to $380, and is now only down 5%.
Volatile moves, yes, but none of this should be all that surprising.
Heading into the report, NFLX stock was up more than 100% year-to-date. And that was the on the heels of a 55% gain in 2017. Clearly, the company needed to report out-of-this-world numbers in order for NFLX stock to head higher.
It didn’t report out-of-this-world numbers. Instead, the numbers were just good. That also isn’t shocking. Netflix’s quarterly numbers are almost always a direct reflection of the company’s original content slate in that quarter. The original content slate last quarter just wasn’t as good as it has been over previous quarters, and as such, the numbers were reasonably weaker than in previous quarters.
So NFLX stock dropped. In a big way — because the gain had happened in a big way, too.
Now, NFLX stock is rebounding. Again, no surprise here. This is a big growth name with a long growth runway. One quarter, during a historically unimportant time of year for Netflix, doesn’t change this company’s long-term growth narrative. Consequently, the dip buyers have arrived, and NFLX stock is rebounding.
Amid all this volatility, what should you do?
Don’t panic. Stay the course. And add on weakness.
Here’s a deeper look.
Netflix’s Quarter Really Wasn’t That Bad
When the report hit the tape and NFLX stock dropped by 15%, there were a lot of headlines coming out proclaiming the end of the Netflix bubble.
But those headlines are misplaced. Yes, the numbers were worse than expected. But that is because the expectations were really, really high. Strip away those expectations, and the underlying numbers are actually quite promising.
Netflix added 5.2 million subscribers in the quarter. That is below management’s 6.2 million guide. But, it is on par with last year’s record second quarter (+5.2 million subscribers). Moreover, the subscriber miss is mostly a result of slower growth in the highly penetrated U.S. market, which is “OK” in the big picture. That market isn’t the big growth driver. International is the big growth driver, and on the international front, net adds numbered 4.5 million. That is up relative to last year.
Although subscriber growth disappointed, pricing growth did not. The average selling price rose 14% year-over-year, and that is better than last quarter’s 12% gain. Therefore, although the subscriber growth narrative hit a road bump, the pricing growth narrative actually improved in the quarter.
Moreover, margins continued on their big upward trajectory. The company maintained free cash flow guidance. And subscriber growth should realistically accelerate in the backhalf of 2018 as new original contents brings new subs (the company is starting to produce exclusive Millarworld comic book content).
In the big picture, then, Netflix’s quarter really wasn’t that bad. Domestic sub growth hit a largely expected road bump due to market saturation. But international sub growth remained robust, pricing trends remained favorable, and margins continued on their upward trajectory.
Netflix Stock Has a Long Runway Ahead of It
Nothing about this quarter changes my long-term outlook regarding NFLX stock.
With 5.2 million net adds this quarter and 5 million projected next quarter, this company is still on track to add between 20 million and 25 million new members each year over the next several years as the direct streaming revolution goes global. Also, with ASP up 14% in the quarter, Netflix remains on track to continue to grow revenues and margins through price hikes over the next several years.
All together, I maintain my outlook that this is a company that can grow to 350 million subscribers in 10 years. Those 350 million subs will likely pay around $15 per month, leading to $63 billion in revenues. Operating margins will likely trend towards 30% as gross margins get a boost from price hikes and opex rates fall due to robust revenue growth.
That combination leads me to believe that Netflix can do about $32.50 in earnings per share in 10 years. A big growth 25X forward multiple on that implies a nine-year forward price target of just over $810. Discounted back by 10% per year, that equates to a present-day value of $345.
Bottom Line on NFLX Stock
Disappointing second-quarter numbers plunged NFLX stock back into fair value territory. But, because the quarter was still good, the long-term thesis remains strong, and investor appetite for streaming plays remains robust, dip buyers arrived en masse at $340.
The next few months could be choppy for NFLX stock as fundamentals catch up to the price tag. But, in the longer haul, NFLX stock can and will head significantly higher.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.