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Last night, Netflix (NASDAQ: NFLX ) posted impressive earnings, and continued its streak of accurately predicting (and slightly underpredicting) subscriber growth one quarter ahead. But as impressive as its subscriber growth has been over the past year, its share price has grown even more dramatically.
Some quick numbers
In its earnings last night, Netflix announced $1.1 billion in Q3 2013 revenue, up 22% year over year, and $32 million in net income, up fourfold from $8 million in the year-ago quarter. Earnings per share surged from $0.13 to $0.52 in the same period.
Combined, the company now has 40.3 million streaming subscribers worldwide, and a bit more than 7 million DVD subscribers domestically. Netflix didn't say how much overlap there is between domestic streaming and DVD, but in the four quarters where it did give the number, that figure worked out to about 72% . Assuming the same percentage, that means the company has about 42.26 million unique subscribers.
Netflix is only giving guidance now for streaming membership (domestic and international), rather than its DVD rental service. Still, its actual results came in 1.8% ahead of the midpoint of its guidance from last quarter.
Fantastic one-year returns
What's really amazing is that a year ago, the share price closed at $68.22 just before Q3 2012 earnings came out. Yesterday, it closed at $354.99. After leaping close to $400 in after-hours trading, it's since fallen to around $330 as of this writing in the wake of cautious comments from CEO Reed Hastings.
Still, in the same year that Netflix's shares surged fivefold, its total subscribers grew by 23.8%. That's definitely not a one-to-one correlation.
This demonstrates that – echoing Hastings' concerns -- share price is as much about perception as it is about company performance. In the past year, Netflix has shown that it is successful and has introduced new original series, member profiles, and upgrades to its user interface, and the market is now expecting even more of the same, bidding the price up higher and higher.
It's quite pleasing to see the company's shares reach new highs, but you should expect that to happen regularly over the next many years, as the company executes on its plan and becomes a truly global business. Taking today's results, and estimating international market potential at four times that of its domestic business (in line with Hastings' comments ), means there is a lot of room to grow. Right now, things are going well, and even with its pullback today, the market's still looking at a rosy future.
How fast is too fast?
The share price has certainly moved quickly, but it's hard to say whether it's risen too quickly. On traditional valuation methods, the company is certainly overpriced, but traditional valuation methods have a real hard time dealing with fast growing companies. Year-over-year subscriber growth of 24% is fast.
One analyst had said that the company could be worth $75 billion ; currently, it's $21 billion. Using some quick calculations, it's pretty easy to get Netflix to a $70 billion market cap. Just multiply domestic revenue of $701.1 million per quarter by five, to reflect a 20/80 split between domestic and international business (and multiply that number by four to get a full year of revenue). Then give the company a 20% net margin, and estimate a P/E of 25.
Please note that this is an extremely rough valuation – but it's in the realm of possibility. How long it takes to get there, though, is unknown. It likely won't happen as quickly as the last 5-fold increase in price.
If you can stomach the likely price volatility and are willing to hold on for several years, an investment today could be rewarding. Just remember that at some point, the market will become disappointed in what Netflix delivers, either through a misstep by Netflix or by having too high expectations, and the share price will be whacked. We've seen a little of that today, and more could arrive without much warning in the months and years to come.
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