The market is having mixed feelings about Netflix's (NFLX -1.12%) third-quarter earnings results. The stock has risen and fallen a few percentage points in each direction in the days following the report.
There was plenty of information to digest, including the effects of the popular hit show Squid Game, so let's dive right in to see if now is a good time to buy Netflix stock.
Revenue and subscriber growth is fueling profits
The streaming content pioneer reported revenue of $7.48 billion in Q3, a 16.3% increase from the same quarter a year ago. The growth rate was a deceleration from recent levels. However, Netflix is following a fiscal year in 2020 that saw it experience a surge of revenue.
It's impressive that the company has retained a large part of the business it attracted during the pandemic. Management highlighted that retention ratios are trending higher than 2020 and 2019. Folks who signed up to Netflix during economic lockdowns are sticking around even as economies reopen.
Netflix added 4.4 million new subscribers in Q3, better than the 3.5 million management had estimated. Popular hit show Squid Game contributed to the increase. The Korean language show was the most-watched show ever on Netflix. A record 142 million people tuned in to the series that first appeared on the streaming service on Sep. 17. Netflix now boasts 214 million streaming subscribers, and it is forecasting another 8.5 million will join in the next quarter.
Fortunately for shareholders, Netflix is turning revenue and subscriber growth into profits. The company reported an operating income of $1.75 billion in Q3, up from $1.3 billion in the same quarter last year. The streaming service business model has efficiencies of scale built inside. It costs Netflix roughly the same to show the same movie to 100 million people as it does to show it to 200 million people. As it adds new subscribers, profit margins should expand.
And that's precisely what is happening at Netflix over time. Between fiscal 2015 and 2020, the operating profit margin grew from 4.5% to 18.3%.
Netflix has excellent prospects at a reasonable price
Despite Netflix's excellent progress in building the business, there remains a long runway for growth. Management estimates there are 1 billion linear TV subscribers worldwide. However, in recent years more folks are preferring to stream their content instead. Streaming services offer more value by allowing you to watch on multiple screens, often costing much less than the alternative, and don't require professional equipment installation.
One risk Netflix is facing is the entry of media giants into the streaming industry. Most notably, Disney has made a big push recently and has attracted 174 million subscribers for its three streaming services (Disney+, Hulu, and ESPN+). However, the foray of new competitors entering the streaming industry could be helping Netflix. If consumers have more content they can buy on streaming services, it could make a choice to cancel linear TV easier. And the low prices for streaming services could allow households to subscribe to multiple services and still pay less than legacy cable.
Overall, Netflix has excellent prospects in the near term and the long term, and the stock is not expensive. Trading at a price-to-earnings ratio of 67, it's selling near the lows of the last five years. It's as good a time as any to buy Netflix stock after it reported third-quarter earnings.