Netflix (NFLX -9.09%) is one of the best-performing stocks on the market this year, but that rally hasn't quieted the bulls who see room for more growth ahead. Instead, optimism is building as investors look forward to the fourth quarter, typically one of the streaming pioneer's strongest seasonal periods.
In fact, shares popped last week following an aggressive upgrade by UBS. The investment firm slapped a $225 price target on the stock and called it a timely buy heading into the streaming video giant's third-quarter earnings report on Oct. 16.
Let's take a closer look at UBS' reasoning for upgrading Netflix stock.
Image source: Netflix.
One shaky assumption
In a note to clients, analyst Doug Mitchelson relied on what I'd call an iffy assumption as support for the upgrade. UBS argued that Netflix's "lackluster stock performance" has set the stage for a large spike ahead.
There are a few ways you could describe shares' recent trajectory, but "lackluster" isn't one that comes to mind. The stock is up over 80% in just the past year, and is the best performer in the S&P 500 in the past decade, with an over 5,800% rise.
UBS is referring to a much shorter time frame -- just the past quarter -- in making the case that there's room for a quick rally ahead. But Netflix has still outperformed the market over that period. In any case, this is one of the more volatile stocks around, and so investors can't glean much from its short-term moves.
But UBS has a point
Mitchelson's more important point is that the company could post surprisingly strong subscriber growth over the next few quarters due to a packed pipeline of content. Specifically, UBS predicts Netflix will beat management's forecast for the fiscal third quarter by adding 1 million new members in the U.S. market, compared to the 750,000 that CEO Reed Hastings and his executive team have projected.
That's possible, but it's also just as likely that Netflix will come up short of its third-quarter target. After all, management aims for accuracy in its subscriber predictions so that it just as frequently overpromises as underpromises.
The team missed by a wide margin last quarter, and Hastings told investors that he doesn't plan to make the same mistake this time around. "We are cognizant of the lessons of the prior quarters when we over-forecasted," he said in a July's shareholder letter. Executives' latest growth prediction for the quarter is optimistic, too, as it implies an almost doubling of membership additions in the U.S. even though the prior-year period included the surprise hitStranger Things.
Looking ahead
The second season of that blockbuster series launches later in October and so it will impact the next quarter's results. The fourth quarter also includes a few other likely membership draws, such as the exclusive movie Bright and a season of Marvel's The Punisher.
A stacked release calendar should keep management (and investors) optimistic about Netflix's subscriber growth potential, especially given that its gains have accelerated so far this year. The company added 10 million new users over the past six months, or 21% more than in the prior-year period. That success puts it in a good position to log its fourth straight year of increasing annual gains.
Data source: Netflix filings. Chart by author.
That said, Netflix's fourth quarter faces a tough comparison against a prior year that saw it add 7 million users, or 2 million more than management had predicted. It's impossible to say whether the company will enjoy a similarly strong finish to 2017, or how the stock might react to those trends over tiny time periods measured in weeks and months.
That's why investors are better off ignoring price targets and following longer-term metrics like Netflix's accelerating annual subscriber growth and its increasing cash demands as it shifts the business away from licensed content and toward risky -- but often lucrative -- exclusive shows and movies.
