Hardly anyone is surprised at the performance of Netflix (NFLX -1.78%) stock over the past several months. Shares are up nearly 30% since the start of 2020 compared to a 6% decline for the S&P 500 in the same period. This was a direct result of the stay-at-home orders that were issued all across the globe, causing an increase in leisure time for consumers as they tried to find ways to pass the time. The company's first-quarter 2020 numbers were remarkable as the streaming giant added an impressive 15.8 million subscribers worldwide. Netflix is one of the rare businesses that is thriving during these challenging times.
Acceleration of digital trends
It is precisely because of the coronavirus pandemic that Netflix had such a notable quarter. The cord-cutting trend has been going on for some time as consumers find less value in a traditional cable subscription and demand better convenience and an upgraded experience. The health crisis simply accelerated the recognition of the importance of having countless viewing options when and how you want them.
With everyone stuck at home, viewership has gone up. In the most recent shareholder letter, CEO Reed Hastings stated, "Like other home entertainment services, we're seeing temporarily higher viewing and increased membership growth." No kidding. Of the 183 million global streaming paid memberships as of March 31, 64 million watched Tiger King, and 85 million watched the original film Spenser Confidential. These are eye-popping numbers. However, Hastings went on to add, "We expect viewing to decline and membership growth to decelerate as home confinement ends."
It's worth noting that Netflix counts one of its shows, movies, or documentaries as part of its viewership metrics if it was playing on screen for over two minutes. But according to LightShed Partners analyst Richard Greenfield, three-quarters of viewers watch at least 70% of a show if they've already seen two minutes of it. Nonetheless, this tempers the excitement surrounding any engagement metrics put out by Netflix. While it was truly an outstanding quarter for the company, the question that should be looming in investors' minds is what happens in subsequent quarters when countries and economies have reopened.
As the U.S. and many countries all over the world start easing lockdown measures, no doubt consumers will begin venturing back into the outside world. After sheltering at home for the better part of three months, many people can't wait to go out and spend money at their favorite hangout spots. This once again puts Netflix in direct competition with myriad entertainment options. Even inside one's home, streaming services are busy fighting for people's attention against the likes of video games. Outside the home, there are far more choices.
With the arrival of summer in the U.S. and the slow reopening of restaurants and other recreational destinations such as Dave & Buster's and AMC Entertainment, Netflix viewership and membership numbers will likely disappoint in the next several quarters as these retail businesses become a first choice for entertainment. Just as the most recent quarter pulled forward a large cluster of subscribers from future quarters, the second and third quarter of this year are more likely to see softer growth.
The future is still bright
We can all agree that Netflix is a wonderful business that will continue delighting its customers with binge-worthy programming. Even if the churn rate increases going forward, the company's intense focus on improving the user experience will benefit it greatly over the long term. There's extreme optimism surrounding the stock following its recent performance. My contrarian mindset is forcing me to stay away until expectations have been lowered, and there's some margin of safety present in the stock price. I think investors would be smart to do the same.