When Netflix (NFLX 1.74%) reports second-quarter results on Tuesday evening, all eyes will turn to the usual business metrics. The stock will probably jump on Wednesday morning if the company beats the growth target of 1 million net new subscribers. Falling short of that target will bring down the stock price instead, which is what happened with April's first-quarter report.
I'll grab my popcorn and watch that figure like everyone else, of course. Subscriber growth is an important measure of Netflix's business performance, after all. But I will also keep a close eye on the company's profit margins, because Netflix needs to break a bad streak of gratuitous operating income.
Image source: Getty Images.
Bad what of what-what, now?
Yeah, you heard me. Netflix has a bad habit of making more money than planned, and more than what is good for the company in the long run.
Throughout the whole coronavirus economy, Netflix has exceeded its own targets for top-line revenue:
|
Quarter |
Revenue Guidance |
Reported Revenue |
|---|---|---|
|
Q1 2021 |
$7.13 billion |
$7.16 billion |
|
Q4 2020 |
$6.57 billion |
$6.64 billion |
|
Q3 2020 |
$6.33 billion |
$6.44 billion |
|
Q2 2020 |
$6.05 billion |
$6.15 billion |
Source: Netflix shareholder letters.
That's just great. In each quarterly report since the spring of 2020, Netflix has collected revenue slightly above management's own projections. The growth engines are humming right along, and sales rose 24% year over year in the first quarter.
Ideally, Netflix would have sunk that extra cash into accelerated content creation. That has not been possible in the COVID-19 era, as social distancing and other disease-fighting efforts have hindered the normal shooting schedules for original Netflix content. Because of this unwanted slowdown in the company's production efforts, operating costs have been lower than expected and resulted in excessive operating profits:
|
Quarter |
Operating Income Guidance |
Reported Operating Income |
|---|---|---|
|
Q1 2021 |
$1.78 billion |
$1.96 billion |
|
Q4 2020 |
$890 million |
$950 million |
|
Q3 2020 |
$1.25 billion |
$1.32 billion |
|
Q2 2020 |
$1.08 billion |
$1.36 billion |
Source: Netflix shareholder letters.
What's the problem?
Netflix exceeded its revenue guidance by an average of 1.2% over this period. Average operating profits came in 12% above expectations. Profits above and beyond management's targets sound like a great problem to have, but there are a couple of downsides to posting overly strong operating profits -- especially when it happens on a regular basis.
- Netflix would really prefer to invest the extra cash into more and better movies and serial shows. Original content is the bait that keeps new subscribers signing on to the service, and it also motivates existing members to stay on as paying customers. Having more of it is better for the company in the long haul. This is the lifeblood of any media streaming service.
- Reporting large profits on the operating-income line results in higher income taxes. Netflix paid $679 million to Uncle Sam over the last four quarters, more than double the $312 million tally of the same period a year earlier.
I would love to see Netflix tamping down its excessive operating profits in the second quarter, preferably as a result of rising content-production costs. That would add more fuel for the company's long-term growth, which is more important than the short-term fluctuations in subscriber growth that will generate most of the headlines around this earnings report.
Bigger is not always better.
