Investors looking for returns that beat the broad market average should consider buying shares of businesses in rapidly growing industries. One such area is streaming entertainment, where an array of competitors have expanded their audiences rapidly by offering more convenience and better value than traditional cable TV.
Netflix (NFLX 1.74%), the pioneer in the space, has grown from 75 million subscribers just five years ago to over 200 million as of the end of 2020. The stock has climbed by a similarly impressive 350% over roughly the same period.
If you're wondering whether or not to buy shares of Netflix now, there are some important things you need to know.
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The business is flourishing
With a years-long track record of beating the market, it would be natural for investors to assume the party for Netflix might be nearing its end, but the company is still operating at an extremely high level.
In 2020, a whopping 37 million members joined the service, and 83% of these additions were from outside the U.S. and Canada. In fact, the Asia-Pacific region was its fastest-growing segment. This is good news for the company, because it shows Netflix can lean on international markets to drive growth now that its home market is becoming saturated.
Sure, the coronavirus pandemic helped boost the business in 2020 as people spent more time than ever stuck at home. However, well before last year, Netflix was riding high from the secular shift to streaming.
And although management has predicted that it will add just six million net new subscribers in the current quarter (compared to the monster first quarter of 2020 when it added 16 million), it's worth noting that Netflix expects operating margin to hit 20% for the full year. The company is proving how well it can scale its business with profitability rapidly rising alongside revenue.
Heightened competition
Not surprisingly, Netflix's success has attracted many competitors, the most eye-catching being Disney+. Since Walt Disney launched that service in Nov. 2019, it has amassed 95 million subscribers thanks to the company's rich catalog of intellectual property and its strong brand.
But while Netflix's average revenue per user (ARPU) was flat in 2020, Disney+ experienced a 28% drop in its most recent quarter due to the lower-cost Hotstar service it offers in India and Indonesia. Furthermore, the enormous scale of Netflix allows it to outspend its peers on new programming. The company spent $12.5 billion on content in 2020, while Disney says it plans to spend $8 to $9 billion annually on Disney+ by fiscal 2024. The success Disney+ has achieved thus far is admirable, but it's nowhere near dethroning Netflix yet.
Then, there are smaller competing services from the likes of Discovery and ViacomCBS. They definitely won't be able to keep up with Netflix when it comes to new content, reducing the likelihood they present a real threat to the industry leader.
New developments
Netflix management made three important announcements regarding the company's financial situation in the most recent shareholder letter that are worth mentioning.
First, the company is expected to be sustainably free-cash-flow positive starting in 2022 (after breaking even this year). Second, Netflix no longer needs to raise capital from external sources to finance its "day-to-day operations." And third, as the company starts to build up excess cash, returning some of it to investors via share repurchases is a real possibility.
This could be a turning point for the company financially, and it's something potential investors should applaud. While other streaming companies are investing heavily in their respective services, many are still struggling to gain traction as Netflix extends its early lead.
In short, don't think that just because a stock has far outpaced the market in recent years, it can't continue to do so. Netflix is thriving, and it still has a long way to go.
