After Earnings, Is Netflix Stock a Buy, a Sell, or Fairly Valued?

• Fair Value Estimate: $500.00
• Morningstar Rating: ★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High

What We Thought of Netflix’s Q2 Earnings

Netflix’s revenue growth accelerated, and another 8 million subscriber additions mean this metric has hardly slowed, even as the company is over a year into some of its recent catalysts – namely, the crackdown on password sharing and offering lower-priced ad-supported subscriptions.

The operating margin remained toward the high 20s, a huge step up from any time before 2024, and this should represent a new normal. Netflix is very profitable.

There are still catalysts ahead to keep revenue growth high in the near term. The crackdown on password sharing isn’t yet universal, and the company isn’t monetising its ad-supported subscribers well. It hasn’t built out and perfected its advertising engine, which should occur over the next few years.

Netflix’s valuation looks a bit high. We think one must assume that recent growth rates persist for several years. The firm’s business is phenomenal, but we expect a slowing and believe the past year has been abnormally great rather than a new normal.

Fair Value Estimate for Netflix

With its 2-star rating, we believe Netflix’s stock is overvalued compared with our long-term fair value estimate of $500, which implies a multiple of 25 times our 2024 earnings per share forecast. We project high-single-digit average annual revenue growth over our five-year forecast, and we believe there’s room for margin expansion, as international markets mature and benefit from greater scale.

Read more about Netflix’s fair value estimate.

Economic Moat Rating

We assign Netflix a narrow moat based on intangible assets and a network effect. Two advantages set the firm apart from its peers. First, it has no legacy assets that are losing value as society transitions to new ways of consuming entertainment at home, letting it put its full effort behind its core streaming offering.

Second, Netflix pioneered its industry, providing a big head start in accumulating subscribers and moving past the huge initial cash burn needed to build a successful streaming service. This subscriber base was critical in creating a virtuous cycle that we doubt can be breached by more than a small number of competitors.

Ultimately, having a successful streaming service is all about offering customers a continuing depth of appealing content at a price point consumers deem reasonable. The industry is not necessarily a zero-sum game, as customers can always add incremental subscriptions. But consumer budgets are finite, so practically speaking, we expect only a handful of streaming services to consistently hold large customer bases, which we think will be necessary to continue funding content investments.

Read more about Netflix’s economic moat.

Financial Strength

Netflix is in good financial shape. It ended 2023 with a net debt/EBITDA ratio under 1.0, holding about $7 billion in cash and $14.5 billion in total debt. More importantly, we believe the years of cash burn are behind the firm. Even after funding all content costs, including spending that was delayed in 2023 due to the actor and writer strikes, we expect over $6 billion in free cash flow in 2024.

The firm does not pay a dividend, nor do we expect it to do so soon. It has a share repurchase program that will provide one outlet for some cash flow. We don’t expect acquisitions, as those have never been a part of Netflix’s strategy, but we believe it has plenty of flexibility to pursue any attractive opportunity.

Read more about Netflix’s financial strength.

Risk and Uncertainty

Our Uncertainty Rating for Netflix is High, largely based on the evolving streaming media landscape and the additional competition the company now faces. In our view, Netflix’s tremendous success is due largely to it being a first mover in the streaming industry and successfully adapting its business model while peers largely focused on their legacy businesses.

Now, nearly every major media company is promoting a stand-alone streaming service. Netflix is more focused on profitability and cash generation than it was in its infancy, meaning prices have risen substantially for consumers over the past several years. Customers now have other choices for streaming subscriptions and the price they pay for Netflix is no longer an afterthought, creating uncertainty around the firm’s ability to attract and retain users.

Read more about Netflix’s risk and uncertainty.

NFLX Bulls Say

• Netflix has created many hit shows exclusively available on its platform that have attracted a massive customer base. The firm’s advantage in cash generation means this virtuous cycle will likely continue.

• Advertising-supported subscriptions will open Netflix to a new base of subscribers and a potentially substantial new source of revenue.

• Netflix has significant room to grow in international markets, where it has already shown promise with local content.

NFLX Bears Say

• Netflix is beginning to face competition that it has not had to deal with in the past. As consumers have more options for quality streaming services, it’s more likely that the platform could get cut out of some consumer budgets.

• Netflix’s US business is mature, with a high penetration of total households, meaning price increases need to be the main source of growth, and consumers may not accept higher prices.

• Creating attractive content is always a gamble. The allure of Netflix’s service will always be tenuous, dependent on continually producing hits.

This article was compiled by Renee Kaplan.