Shares of Netflix (NASDAQ:NFLX) have roared higher in 2019, rising nearly 40% year-to-date. Essentially, favorable market and economic conditions have converged on continued strong subscriber growth numbers for the streaming platform. Also, there’s reason to believe that this big 2019 rally in NFLX stock will kick into higher gear this summer.
Specifically, three reasons support the nearer-term bullish case for Netflix stock:
- Netflix stock is still undervalued relative to its long-term growth potential.
- Low interest rates will keep growth stocks like NFLX on a winning trajectory for the next several months. Better yet, a rate cut will light a fire under these growth firms.
- Netflix’s recent original content portfolio, headlined by the third season of Stranger Things, has been very strong. This lends itself to blowout second-quarter subscriber numbers and a strong third-quarter guide.
As such, on the heels of a 40% year-to-date rally, I don’t think now is the time to get bearish. Instead, I think now is the time to double down the bull thesis.
Netflix Stock Is Still Undervalued
In the broader picture, Netflix stock is still undervalued relative to its long-term growth prospects.
At the end of 2018, Netflix had about 140 million paid subs. Also, at the end of 2018, there were around 300 million global streaming video-on-demand (SVOD) households. Thus, Netflix’s platform had just under 50% penetration into the global SVOD market.
Over the next several years, four things will happen. First, the SVOD market will grow by leaps and bounds as viewing consumption continues to shift from linear TV to internet TV. Industry reports suggest the SVOD market will probably wind up gaining around 600 to 700 million households by 2025.
Second, Netflix will maintain roughly 50% share in this market because the platform has compelling original content which consumers want to watch. Plus, this content can’t be found anywhere else, especially for the bargain price of just $10 to $15 per month.
Third, Netflix will hike prices gradually as the volume of original content on the platform grows. Fourth, those price hikes coupled with increased scale will drive robust profit margin expansion.
In sum, then, Netflix could be looking at somewhere north of 300 million subs by 2025, at an approximately $15 monthly fee. In this context, profit margins that could close in on 30%. If you math that out, $27.50 in earnings per share seems entirely doable by fiscal 2025.
Based on a big-growth 25x forward multiple and a 10% discount rate, that equates to a 2019 price target for NFLX stock north of $425. Thus, around $370, NFLX stock is undervalued.
Low Rates Will Boost Netflix Stock
Importantly, the current low-rate interest environment is a favorable one for growth stocks. As this environment persists over the next few months — and potentially even accelerates with a rate cut this summer — segment players like NFLX stock will stay in rally mode.
Low rates help growth stocks by promoting risk-on attitudes from investors and lowering the discount rate on future profits. That’s why, as rates and fixed-income yields have plunged in 2019, stocks have posted their best start to a year in over two decades.
Going forward, rates project to remain lower for longer. Indeed, the Federal Reserve may even cut rates this summer. Such a cut would provide a boost to the whole stock market. That includes an especially large boost to growth names like NFLX stock.
With a triple-digit forward-earnings multiple and a 20%-plus revenue growth rate, Netflix stock unequivocally derives a majority of its value from future profits. Thus, low rates will provide a favorable market backdrop for NFLX stock over the next few months.
Netflix Stock Will Benefit from a Strong Q2 Print
The single most important driver of Netflix stock is the company’s quarterly earnings reports. And the single most important number in those reports is the subscriber tally. Specifically, if sub growth this quarter and the guide for sub growth next quarter are both above expectations, Netflix stock will charge higher in response.
This is exactly what should happen this July. Netflix’s sub numbers move in response to the platform’s original content portfolio. When this content portfolio is robust, the sub numbers are very good. When it’s not so robust, the sub numbers aren’t so hot.
Over the past several months, the original content line-up has been exceptional. In July, that line-up has remained exceptional, headlined by the third season of Stranger Things. This series not only broke all sorts of viewership records, but also notched incredibly high scores from fans on IMDb.
Bottom Line on NFLX Stock
Netflix stock is up big year-to-date. But there’s reason to believe that this rally will still accelerate this summer. Relative undervaluation coupled with a favorable market backdrop and strong quarterly numbers should drive a summer rally in NFLX stock.
As of this writing, Luke Lango was long NFLX.
