After briefly surging past $400 earlier this year, shares of Netflix (NFLX -1.13%) took a breather a few months ago. The streaming-TV giant's worse-than-expected member growth in Q2 spooked some investors and shares sold off about 13% during the trading day following the quarterly earnings release.
With Netflix's third-quarter earnings release less than two weeks away, the company will get a chance to strengthen the narrative surrounding its stock. To impress investors, Netflix will need to report improving margins and strong member growth.
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Operating margin
One metric Netflix investors watch closely is its operating margin. The metric, which is calculated by dividing operating income by revenue, gives investors a window into Netflix's improving profitability.
Netflix's operating margin in Q2 was 11.8%, impressively up from 4.6% in the prior-year period. Such a big jump in the company's operating margin meant its operating income soared 262% year over year. And Netflix's meatier operating margin also played a key role in the company's surging earnings per share, which rose from $0.15 in the year-ago quarter to $0.85.
For Q3, management expects another significant increase in the company's operating margin compared to the year-ago quarter. Netflix guided for an operating margin of 10.5% in Q3, up from 7% in the third quarter of 2017.
Subscriber growth
Overall, Netflix's member growth has been a bright spot for the company over the trailing-12-month period. It was only in the company's most recent quarter that investors were disappointed with member growth -- and that disappointment was partly due to investors' high expectations for the metric lately.
Over the past 12 months, Netflix's members have increased from 104 million to 130 million, representing strong 25% year-over-year growth. But in Q2, Netflix's 5.15 million member additions were more than 1 million below management's forecast for 6.2 million member additions during the quarter.
For Netflix's third quarter, management has tempered its expectations. The company guided for 5 million new members during the quarter -- lower than both the third quarter of 2017, when Netflix added 5.3 million members, and Q2's worse-than-expected 5.15 million additions.
Specifically, management guided for 650,000 new members in the U.S. and 4.35 million new members abroad.
Can Netflix hit its guidance this time? Based on the fact that Netflix has met or exceeded its guidance for member additions in seven of the last 10 quarters, there's certainly a decent chance. But investors should keep in mind that Netflix's forecast for member additions aims for accuracy and is not a conservative estimate. "As a reminder, the quarterly guidance we provide is our actual internal forecast at the time we report and we strive for accuracy," Netflix explained in its second-quarter shareholder letter, "meaning in some quarters we will be high and other quarters low relative to our guidance."
Netflix reports earnings on Tuesday, Oct. 16 after market close.
