In this segment from Market Foolery, host Mac Greer, Million Dollar Portfolio's Matt Argersinger, and Supernova and Rule Breakers' Aaron Bush dip into the Fool mailbag and find a request for them to explain a bit of investing arcana. Last week, Market Foolery commentators noted that streaming video leader Netflix (NASDAQ:NFLX) was profitable last quarter, but also cash-flow-negative. In short, wondered the listener, how can those two states coexist? Tune in to hear the Fools break it down.
A full transcript follows the video.
This video was recorded on April 19, 2017.
Mac Greer: Let's go to the Fool mailbag. From Seth A. Smith, "Yesterday, you were talking about how Netflix is profitable, but cash-flow-negative. Can you please explain how this happens? I don't understand the math."
Matt Argersinger: That's a common misunderstanding with Netflix and a lot of companies that capitalize a lot of their costs. In Netflix's case, they're paying a lot of upfront cash for content that they're going to develop in the future, that will be shown in the future, and they'll generate revenue from. The accounting is wonky in the sense that they are making a lot of real cash payments, cash is coming off the balance sheet, and it's an operating cash flow outflow for content it's not going to be revenue-generating or expensed into the future. So, the income statement you're seeing today doesn't reflect content that Netflix is paying for today, for content that's coming down in six months, a year, or even several years, because content can take time. If you're building a new show or making a movie, you can start investing in that today, but that film or show might not hit for another year or a year and a half. That's just how the accounting works. Netflix has been doing this for years. The fact that they're investing so much in original content, $2 billion in just the last year alone, and they're going to spend even more of that in the future, that means they're going to be negative cash flow generating, even though today, they're reporting a profit based on current operations.
Greer: So, how much weight should investors give when they hear Netflix is profitable? You seem to be saying that's a bit misleading.
Argersinger: I would say it's very misleading. Any company that depends on a significant amount of capital investments, whether you're a software company or internet streaming like Netflix, I think it's really important to look at free cash flow. If you add those expenses back in, they're a negative free cash flow company. When Netflix ultimately -- they expect to -- hit that tipping point when they're generating so much cash, the subscriber base is so big that they're also generating free cash flow even still investing in new content that's when you say Netflix is truly a profitable company.