Something remarkable happened after Netflix Inc (NFLX 1.66%) reported earnings this week: The stock barely moved.
In the usually volatile after-hours session, the stock initially fell a couple of points as subscriber growth came in slightly below guidance, but then it moved modestly into the black on the earnings call.
On Tuesday, the first full day of trading, the stock closed down 2.6%, nearly erasing the previous day's gain.
For years, Netflix has been the most volatile stock on the S&P 500, with its post-earnings swings averaging in the double digits, but this week's report marked the second in a row to receive only a muted response from the market as its January report prompted just a 3.9% bump in the stock. By contrast, the average swing in Netflix's four reports last year was more than 11%.
Image source: Netflix.
There's a good reason for that shift, and Netflix management is pushing it in that direction. In Monday's earnings report, management made an important change to the results table at the top of its letter to shareholders. For the first time, Netflix shined the spotlight on conventional financial figures like operating income and earnings per share rather than just focusing on subscriber growth.
The company explained the move, saying in the letter, "Starting this year, we can be primarily measured by revenue growth and (global) operating margins as our primary metrics," as opposed to subscriber growth and U.S. contribution margin.
Reaching maturity
Netflix completed its international expansion last January, and with that, CEO Reed Hastings signaled that the company would soon switch gears by delivering material profits in 2017. Indeed, the leading video streamer looks set to deliver on that promise as it just posted its most profitable quarter ever, with earnings per share of $0.40 and an operating margin of 9.7%.
Without any more territories to expand into, Netflix no longer has to worry about doing the legwork necessary to enter new countries -- like negotiating contracts and building brand recognition -- and it can instead focus on ramping up profits as it adds new subscribers. Subscriber growth should also be more consistent now; it has been on a year-to-year basis in the U.S. since there aren't any new market launches to jolt it.
Hastings said the company had come to see the quarterly variances in subscriber growth as "mostly noise," and he laid out his long-term vision for the business, saying:
Our operating margins are our key indicator of improving global profitability; they are already growing and we plan to keep them growing for many years ahead. Eventually, at a much larger revenue base, original content and revenue growth will be slower, and we anticipate substantial positive free cash flow, like our media peers.
What it means for investors
For years, Netflix was the one of the most exciting -- and lucrative -- stocks on the market. Following the Qwikster boondoggle in 2011, the stock mounted a surprising comeback, gaining nearly 1,000% over the last five years. It was a battleground stock the entire time, with analysts hotly debating its prospects and the possibility that it would ever generate significant earnings.
Now, that debate is pretty much over. Netflix is profitable in its mature international markets like Latin America, Canada, and Europe, and it's fast gaining traction in newer ones like Asia, the Middle East, and Africa. It's already reached its 2020 goal of 40% contribution margin in the U.S., hitting 41.2% in the first quarter.
Without the element of surprise it once had in quarterly earnings reports, and with the $60 billion valuation it now carries, the stock is much less likely to double in a single year, as it did in both 2013 and 2015, barring a sudden surge in subscribership and, therefore, profits. Its P/E ratio remains in the triple digits, meaning the stock will continue to be more volatile than a traditional blue chip, but all of the bear arguments against Netflix have essentially been revealed as false.
As Hastings has said many times before, Internet TV is taking of the world, and the market for it is huge. Netflix is the industry leader, and its path to profitability is clear. The stock will continue to be a winner, but don't expect the eye-popping returns it once generated.
