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This Single Metric Will Drive Netflix's Fortunes When the Company Reports Earnings

By Danny Vena - Oct 14, 2019 at 11:00AM

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Investors will key in on this one number more than any other.

Netflix (NFLX 1.67%) stock has been a non-stop thrill ride for shareholders, though not without its share of challenges along the way. Over the past year, the company's stratospheric growth appeared to be slowing, causing some investors to question the stock's frothy valuation.

When subscriber growth hit a rare snag last quarter, Netflix plummeted 30% in the wake of its earnings report, though it's currently only down about 20%. Fear of looming competition combined with lower than expected customer additions helped stoke investor fears that the tech giant's best days may be behind it.

All eyes will be on subscriber growth when Netflix reports the financial results of its 2019 third quarter after the market close on Wednesday, October 16. Let's look at why investors will be most interested in Netflix's subscribers when the company reports earnings. 

A teenage girl laying on a bed smiling while talking into a walkie-talkie

Millie Bobby Brown in a scene from Netflix's Stranger Things 3. Image source: Netflix.

It all hinges on sub growth

A recap of last quarter helps to illustrate why the investment community appears to be so obsessed with Netflix's customer numbers.

Netflix reported the addition of 2.7 million net additions in the second quarter, but that was a far cry from the 5 million the company had forecast or the 5.45 million it added in the prior-year quarter. This was accompanied by a sequential decline in Netflix's domestic customer base, which fell from 60.2 million in the first quarter to 60.1 million in Q2.

Some believe Netflix's recent price increase -- its fourth in five years -- led to these sub-par numbers and that they are a harbinger of things to come. Investors have given the company a pass on achieving greater margins and profits, surmising they will improve as the customer rolls increase. They might not continue to be so understanding if Netflix's subscriber growth were to stagnate.

A perfect storm

The headlines have been filled with talk of competing services that will be launching in the coming months. Apple (AAPL -0.23%) announced last month that its Apple TV+ service will debut on Nov. 1 for $4.99, about half the price many were expecting. The company also offered another deal, providing a year of free service to any customer who purchases a new device, signaling that it means to be a serious competitor.

The other elephant in the room is media giant Disney (DIS -0.11%), which will be launching its own streaming service -- Disney+ -- on Nov. 11 for $6.99 per month, or $69.99 per year, which works out to just $5.83 per month. Members of D23, Disney's fan club, were offered an even better deal, with a three-year subscription for $141 -- more than 30% off its already low price. One should never underestimate the power of the Disney marketing machine to reach its many devotees, enabling it to rake in hoards of new subscribers.

This combination of low price and aggressive incentives from upcoming competitors could potentially eat into Netflix's subscriber base, thereby disrupting its long history of growth.

Don't count Netflix out just yet...

It's important to remember that last quarter wasn't the first time Netflix wildly overestimated its quarterly growth totals. In Q2 2018, Netflix reported 5.15 million subscriber additions, falling far short of its forecast of 6.2 million. This resulted in much wailing and gnashing of teeth among Netflix investors and Wall Street prognosticators, who wondered if the company's best growth days were behind it -- sound familiar?

Netflix management explained at the time, "The quarterly guidance we provide is our actual internal forecast at the time we report, and we strive for accuracy, meaning in some quarters we will be high and other quarters low relative to our guidance." 

As if to prove the point, Netflix came roaring back in Q3 of last year, adding nearly 7 million new subscribers, blasting past its estimate of 5 million for the quarter. This illustrates that forecasting could be more art than science, and the company's growth story remains intact.

For the third quarter of 2019, Netflix has forecast 7 million new subscribers, with about 800,000 domestic additions and 6.2 million new international customers. 

Given the similarities to last year and the recent release of Stranger Things 3 -- the company's biggest hit -- it isn't a stretch to think that this quarterly report may be eerily similar to last year's blockbuster quarter, and the upcoming earnings report could yield surprising upside for Netflix. We'll know for sure next week.

Danny Vena owns shares of Apple, Netflix, and Walt Disney and has the following options: long January 2021 $190 calls on Apple, short January 2021 $195 calls on Apple, and long January 2021 $85 calls on Walt Disney. The Motley Fool owns shares of and recommends Apple, Netflix, and Walt Disney. The Motley Fool has the following options: long January 2021 $60 calls on Walt Disney, short October 2019 $125 calls on Walt Disney, short January 2020 $155 calls on Apple, long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and long January 2020 $150 calls on Apple. The Motley Fool has a disclosure policy.

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