Lots of things stand out when you look back at 2020. It was the year of the pandemic. But it was also the year of streaming. Netflix (NFLX 0.39%) is the leader in streaming, but Roku (ROKU 2.66%), Walt Disney (DIS 0.84%), AT&T's (T -1.00%) HBO Max, and others have all gotten time in the spotlight this year.
That means their stocks have been gaining momentum as well, or at least a lot of buzz. Here's one thing you need to know before you invest in streaming stocks.
Providing content for people staying home
Netflix certainly didn't anticipate the COVID-19 pandemic when it started streaming content way back in 2007. However, the pandemic has accelerated subscription streaming service adoption for the streaming giant and its rivals. Netflix had extremely strong subscription growth during the pandemic, particularly in the second quarter ended June 30, with a 27% increase when lockdowns were at their worst.
The company neared the 200 million subscriber mark in the third quarter and is projecting to break it in the fourth quarter, although it's also forecasting slower growth as the pandemic seems to be coming to an end.
Disney offers several streaming options, including the new Disney+, ESPN+, Hulu, and other international offerings. Disney+ has amassed nearly 90 million subscribers in one year, and in total the company has over 135 million subscribers.
The media giant is now projecting up to 260 million Disney+ subscribers and 350 million total subscribers by 2024, potentially sliding into the top streaming spot.
Roku grew active accounts 43% to 46 million and revenue 73% in the third quarter ended Sept. 30. Roku has bit of a different business, providing both equipment and subscription options for other streaming apps.
High stock gains accordingly
Companies with streaming services as a significant business segment have witnessed market-beating stock returns since the March plunge. Disney, despite its closed parks, is up 25% this year, due to strength in streaming. Netflix is up 63%, and Roku has gained 156%. AT&T, whose subscription streaming segment is less than 20% of total revenue, is down 27%. But here's the catch: These are companies with a lot of future potential that will continue to make sales, but it's hard for them to generate cash.
Consider Netflix, the original streaming site and leader of the pack. While it's posted earnings increases over the past three quarters, it typically posts negative cash flow. Why is that so? It only accounts for a portion of content costs annually -- meaning the cash is recorded as going out, but only a portion of that is noted as an expense, since the content is considered an asset with continued value. This leads to higher net income despite the cash outlay, and the rest of that expense is recorded over the next several years.
It needs to invest heavily in content in order to please and retain customers, and it will need to reach a certain threshold of subscriptions to cover annual content production costs to stay cash flow positive, regardless of overall revenue growth. Cash flow was positive for the past three quarters, leading it in the right direction. As subscriptions increase, the ensuing economies of scale should ensure consistent positive cash flow.If that doesn't happen, it will eventually affect the company's liquidity.
Roku posted a surprise profit in the 2020 third quarter along with a huge surge in revenue. Management attributed that to more advertising, subscriptions, and content. It also made a celebrated deal to stream HBO Max content, giving it greater potential for viewers and ads.
Disney+ is still in the rollout stage, which means the company is pouring money into marketing the service. While its reception has been tremendous, the company still says the streaming service won't be profitable until 2024.
Investors are obviously very confident about these companies, and rightly so. But they may not churn out reliable profits for a while. In the streaming business, it'd be prudent to keep an eye on the company's ability to generate cash for long-term stability and investing success.