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Netflix Stock: Will Earnings Impress?

By Daniel Sparks – Oct 8, 2020 at 8:45AM

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Growth may slow after a stellar first half of 2020.

Netflix's (NASDAQ:NFLX) business has benefited from the pandemic thus far. The streaming juggernaut's subscribers have been easily beating analyst estimates during the coronavirus pandemic, with first- and second-quarter paid member additions coming in at about 8 million and 2 million  ahead of analysts' average forecasts,  respectively.

This strong performance relative to expectations, of course, means investors are likely hoping for similar outperformance in Q3. Going into Netflix's third-quarter update on Oct. 20, here's a preview of what investors should look for from the streaming specialist.

A person watching a show on their laptop while eating popcorn.

Image source: Getty Images.

Expect slower growth

Following two strong quarters that benefited from consumers sheltering at home and spending more time in front of the TV, Netflix management is anticipating much slower growth in Q3. Specifically, management guided for 2.5 million new members during the period. This is down from about 10 million in Q2 and 16 million in Q1.

"As we indicated in our Q1 2020 letter, we're expecting paid net adds will be down year over year in the second half as our strong first half performance likely pulled forward some demand from the second half of the year," the company said in its second-quarter shareholder letter. In addition, management said that it's up against some tough comparisons in the third quarter of 2019, which were positively impacted by new seasons of Stranger Things and Money Heist.

Management strives for accuracy with its quarterly forecasts, as opposed to building in significant conservatism as many other companies do. Investors are thus likely still hoping that Netflix's subscriber growth meaningfully exceeds management's forecast for the period.

Checking on Netflix's operating margin

Another key metric that investors should watch when Netflix reports its third-quarter results is its operating margin. For the full year, Netflix is targeting an operating margin of 16% -- up from 13% in 2019 and 10% in 2018. Continued expansion of this key profitability metric is one of the reasons investors are so willing to pay a premium price for Netflix stock. They're betting that rapid revenue growth paired with operating leverage will lead to outsize earnings growth (relative to revenue growth) in the coming years.

In Netflix's second-quarter update, management said it was currently on track to exceed its target for a 16% operating margin. In addition, the company notably said it was expecting its operating margin in 2021 to be 21%. When Netflix reports earnings after market close on Tuesday, Oct. 20, look to see if this is still the narrative.

Daniel Sparks has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.

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