Investors are pressing pause on Netflix (NFLX -0.08%). The streaming stock got torched Thursday afternoon after it reported disappointing guidance in its fourth-quarter earnings report. Shares plunged 20% in after-hours trading.
The sell-off itself wasn't surprising. Netflix called for just 2.5 million subscriber additions in the current quarter, an unusually weak forecast for a seasonally strong quarter. Worse, it sees revenue growing just 10% to $7.9 billion, which would be its slowest growth in a decade.
If you're thinking of selling Netflix stock on the news, you're not alone. Wall Street analysts trashed the streamer following the report, with one calling it "dead money" and another saying "the good old days may be gone." Indeed, the days of Netflix posting breathless growth quarter after quarter are likely over, barring an unforeseen change to the business. But if you're ready to part with Netflix shares following the stock plunge and the disappointing guidance, you should be aware of two things.
Image source: Netflix.
1. Shares have never been cheaper in the streaming era
Netflix may no longer be behaving like a growth stock, but the good news is it's no longer priced like one either. Following the post-earnings dip, Netflix shares now trade at a price-to-earnings ratio of just 36. That's only modestly higher than the S&P 500's P/E ratio of 26, and cheaper than it's ever been since 2012 when the company made streaming its primary business, leaving the DVD-by-mail operation behind.
While Netflix's growth has slowed in recent years, it's turned into a profit machine. The company just finished a year with a 21% operating margin, making earlier cries about cash burn look silly. In 2022, management actually expects a modest decline in operating margin, at 19%-20%, but that's primarily due to a stronger U.S. dollar, which is expected to shave 2 percentage points off that metric.
The company is still sticking to its long-term promise of delivering an average increase in operating margin of 3 percentage points a year, meaning by 2024 it expects to keep 28% of its revenue as operating profit. Even as revenue growth is slowing, profit margin will accelerate to make up for it. 2022 is just a noisy year because of foreign exchange and outsize growth in profit margins over the last two years.
2. Revenue growth will improve after Q1
Netflix didn't provide guidance beyond the first quarter, and there's no question the Q1 numbers are disappointing. With 2.5 million subscriber additions, this would be its weakest Q1 performance in at least five years, and a slowdown in revenue growth from 16% in Q4 2021 to 10% in the current quarter seems severe.
However, management seemed to imply that revenue growth would improve after the first quarter. It noted that its first-quarter content releases were weighted toward the end of the quarter with two big releases (Bridgerton and The Adam Project) slated for March, meaning the impact of those will also be felt in Q2. Additionally, the company is raising prices on all North American subscriptions with the standard U.S. package going from $13.99/month to $15.49/month. The financial numbers should begin to benefit from that price hike in the second quarter as about 40% of its revenue still comes from North America. Netflix's last price hike in the U.S. was in October 2020 so Q1 represents a lull where the revenue numbers don't get a tailwind from higher U.S. prices. From Q2 on, revenue growth should improve to at least the mid-teens.
The new Netflix reality
Keeping those factors in mind, it's also worth remembering that Netflix's heady growth days are probably over. It's hard to see the stock doubling in a year as it did multiple times during the 2010s, now that its business is much more mature and revenue is only growing in the teens.
Still, considering the stock's valuation, a probable rebound in performance after the first quarter, and a number of valuable competitive advantages including its leadership in a huge growth market, the stock looks like a good bet to outperform the S&P 500 over the next three to five years.
