Three months ago, Netflix (NFLX -9.09%) stock plunged after the company reported what it described as "a strong but not stellar Q2" performance. The streaming video leader missed its subscriber growth forecast by a wide margin, despite doubling its marketing spending year over year.
But Netflix got back into investors' good graces last week, as it posted third-quarter results that soared past its guidance on virtually all key metrics. That said, its fourth-quarter outlook wasn't particularly impressive. The recent earnings report represents an "all clear" signal for buying Netflix shares only if you don't put much stock in the company's Q4 forecast.
Results soar past expectations
In July, Netflix projected that it would add 5.15 million paid subscribers during the third quarter: 700,000 in the U.S. and 4.45 million in international markets. That would have been roughly in line with Q3 2017, when it added 4.99 million paid subscribers. But on a brighter note, the company expected to post earnings per share of $0.68 on $3.99 billion of revenue -- up substantially from $0.29 and $2.99 billion a year earlier.
Revenue came in at $4 billion, nearly hitting Netflix's estimate right on the nose. Otherwise, Netflix simply crushed its internal projections last quarter.
In the U.S., the company added 1 million net paid subscribers, surpassing its forecast by more than 40%. International paid subscriber growth came in at 5.07 million -- a record for the third quarter, and 14% ahead of Netflix's estimate.
Image source: Netflix.
Netflix achieved this acceleration in subscriber growth even as it reduced marketing spending by 17% sequentially. (Marketing costs still increased 39% year over year.) As a result, EPS more than tripled year over year, reaching $0.89 -- 31% ahead of the company's forecast.
Guidance isn't nearly as bullish
These numbers make it clear that Netflix is still a high-growth company. But given that Netflix trades for about 135 times analysts' 2018 EPS estimates, this level of growth still might not be enough to justify the stock price.
The streaming video pioneer's fourth-quarter forecast represents a potential caution flag in this regard. Subscriber growth is expected to be strong, with 7.6 million net paid additions, versus 6.62 million a year earlier. But Netflix estimates that revenue growth will slow to 28%, compared with 40% in the first half of 2018. Meanwhile, it expects content and marketing costs to surge, causing EPS to fall to $0.23 from $0.41 a year earlier. That would bring full-year EPS to approximately $2.61, or $0.10 below what analysts had been expecting.
Netflix says that lumpy spending is the only reason that profits are set to plunge this quarter. It still projects that its operating margin will expand by 2 to 3 percentage points on an annual basis in 2019. Nevertheless, Netflix is acknowledging that it can't sustain its recent rate of profit growth even in the short term.
Everything depends on what happens next
The optimistic take on Netflix's guidance is that it might be too conservative. Netflix surpassed its EPS forecast by a wide margin last quarter, and it has beaten its subscriber-growth guidance in most quarters over the past few years.
That said, Netflix executives have repeatedly stated that they don't lowball the company's forecasts. In each earnings report, the guidance for the following quarter is based on the midpoint of Netflix's internal projections. Investors got a (temporarily) costly reminder of that fact three months ago.
If Netflix does beat its guidance this quarter, it would suggest that the company remains on the incredible growth trajectory that has caused its stock to surge more than 600% over the past five years. But if it falls short, it might be a sign that Netflix is finally beginning the transition to maturity (and slower growth). Given the stock's sky-high valuation, that would be bad news indeed for shareholders.
