Netflix Inc. Smashes Expectations -- Is It Enough to Support the Stock?

Netflix's business continues to deliver, but the stock's valuation implies huge promise.

Jan 22, 2014 at 7:00PM


Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

U.S. stocks finished the session essentially unchanged on Wednesday, with the S&P 500 up by just 0.06%. The narrower Dow Jones Industrial Average (DJINDICES:^DJI) fell by a quarter of a percent, as the market punished its second-largest weighting, IBM (NYSE:IBM), for its seventh consecutive quarterly revenue decline, pushing it down 3.28%. However, the most heavily anticipated earnings announcement was that of Netflix (NASDAQ:NFLX), which came after the market's close. If the after-hours session is any indication, investors are more than satisfied with the streaming video provider's numbers -- Netflix shares were up 17% just before 7 p.m. ET.

Netflix, which was the best-performing stock in the S&P 500 in 2013, appears to be firing on all cylinders when it comes to the business, too. In the fourth quarter, earnings per share of $0.79 exceeded Wall Street's expectations for $0.66, while revenue of $1.175 billion was in line with analysts' consensus estimate, according to Thomson Reuters I/B/E/S.

More importantly, though, Netflix exceeded its own guidance for contribution margin, achieving 23.4% against 23.2%, thereby exceeding its goal of a four-percentage-point year-on-year improvement on this profitability metric by 20 basis points (one basis point is equal to a hundredth of a percentage point.) Contribution margin is the ratio of the contribution profit to revenue; contribution profit excludes technology and development, and general and administrative costs are accounted.

In its third-quarter earnings announcement, Netflix had also said it expected domestic net subscriber additions of 2 million in the fourth quarter -- the same number as in the year-ago period. Netflix also "beat" on this critical metric with net additions of 2.25 million. That's a good result -- as CEO Reed Hastings and CFO David Wells point out in the investor letter:

Running equal to, or slightly above, prior year net additions is a great outcome because it implies that at 33 million domestic members we're still in the middle section of the S curve of consumer adoption, with years of member growth ahead of us.

That momentum is helpful when you're running on the Wall Street earnings treadmill: Netflix's earnings-per-share forecast for the current quarter of $0.78 is a penny above the current consensus estimate. All told, it's not surprising that investors are cheering the report after hours, but if you assume that the stock was already somewhat overvalued (which I did), what is one to make of this near one-fifth pop in the price?

I can't be the only wondering the same thing. At $390, the price is 10% above the closing level on Oct. 21 -- the date of the last earnings announcement, at which Hastings himself warned investors that Netflix's stock appeared overpriced. Netflix's growth prospects are good and the economics of the business are compelling, but the company remained free cash flow negative in 2013 (although quarterly free cash flow has been positive in the last three quarters). With just $5 million in free cash flow in the fourth quarter, there remains much to be done in order to justify a $20-plus-billion market value. Only investors with a multi-year time horizon and a tolerance for volatility ought to open a position at current prices.

Netflix quadrupled in 2013; here's the one stock that could make you rich in 2014
There's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

Fool contributor Alex Dumortier, CFA, has no position in any stocks mentioned; you can follow him on Twitter: @longrunreturns. The Motley Fool recommends Netflix and owns shares of IBM and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information