Netflix (NFLX 4.17%) is scheduled to report second-quarter earnings on July 20, and the expectations all around are that results will not be great. The company experienced a surge in new subscribers in 2020, and that pulled forward demand from 2021.
Still, Netflix is on an excellent long-term footing, and investors should consider the stock even if second-quarter results are pedestrian. That is especially true if the stock price falls after results are announced on Tuesday.
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A bad quarter is no sweat for Netflix
The pandemic surge allowed Netflix to raise subscriber totals to 208.66 million as of March 31. In its first-quarter shareholder letter, Netflix forecast that it would add a net of 1 million subscribers in Q2. If results turn out as forecast, that would be the smallest quarterly subscriber gain dating back at least five years. The main culprits of the slowdown are the surge in additions in 2020 and a reduction in content creation due to coronavirus-related restrictions last year.
However, that should not discourage long-run investors. The 208 million subs the company already has will bring in over $20 billion in annualized revenue. It is already the No. 1 streaming provider when measured by subscribers. Going forward, it can outspend most competitors on new content, which gives it a strong moat around its leadership position. It has already committed to spending a whopping $17 billion on content this year and impressively will remain cash flow neutral. No competitors can spend such a large sum on streaming content and not generate large cash flow deficits.
Furthermore, the large content budget makes it more attractive to existing and new subscribers. Existing viewers stay because Netflix keeps adding fresh content, and new subscribers join because of a large trove of content they probably haven't watched yet.
Economies of scale are bearing fruit for Netflix. Indeed, from 2012 to 2020, it increased its operating profit margin by over 10-fold from 1.4% to 18.3%. The costs to serve the next 1 million subscribers are small relative to the revenue they bring.
What this could mean for investors
Analysts on Wall Street expect Netflix to report revenue of $7.32 billion and earnings per share of $3.15, which would be increases of 20.3% and 98%, respectively. That being said, the metric most likely to move the stock price following the report is the subscriber total. That's because revenue is more predictable, and quarterly earnings are more a function of the timing of content production.
If that metric falls short of expectations and the stock price falls in response, it could be an opportunity for investors to start a position in Netflix. The long-run secular tailwind from folks switching from watching linear TV to streaming content is not likely to reverse. The latter is simply more convenient in a world where people have multiple screens in addition to a TV and prefer the option to view content on all screens. What's more, streaming often costs less than a traditional cable bundle.
As the leading streaming content provider, Netflix's position will allow it to continue benefiting from that long-run tailwind. Therefore, any pessimistic narratives resulting from short-term volatility could be taken as opportunities to buy.
