5 Red Flags for Netflix's Future

Netflix's (NFLX -0.63%) stock has lost nearly 48% of its value after hitting a record high of $700.99 per share last November. Roughly half of that two-month decline occurred in a single day after the streaming video giant posted its fourth-quarter earnings report on Jan. 20.

Netflix's headline numbers didn't initially seem that bad. Its revenue rose 16% year over year to $7.71 billion, matching analysts' expectations. Its earnings per share rose 12% to $1.33, beating estimates by $0.50. Unfortunately, a closer look at Netflix's earnings report reveals a few soft spots which spooked the bulls.

Let's review five of the red flags for Netflix's future -- and whether or not they'll prevent its stock from bouncing back.

Image source: Getty Images.

1. Slowing subscriber growth

Netflix's subscriber growth accelerated in 2020 as people streamed more videos at home throughout the pandemic. However, its growth decelerated throughout 2021 as those lockdown measures were relaxed.

In October, Netflix had expected its number of paid subscribers to grow 9% year over year to 222.06 million in Q4. However, it missed that forecast by about 220,000 subscribers:

Source: Netflix. YOY = Year over year.

For the first quarter of 2022, Netflix expects its number of paid subscribers to grow 8% year over year to 224.34 million.

2. Concerns about the competition

Netflix continues to grow, and it's still the world's largest paid streaming video platform. But in its shareholder letter, Netflix management also admitted that the competition had "intensified over the last 24 months" as other media companies promoted their own streaming services.

During the conference call, co-CEO Reed Hastings said there was "more competition than there's ever been," but noted that Netflix had consistently gained new subscribers despite competing against Disney's (DIS -0.04%) Hulu and Amazon's (AMZN 3.43%) Prime Video for more than a decade.

Disney ended its latest quarter with 179 million subscribers across all of its services, while Prime Video attracted 175 million unique viewers throughout 2021. All three companies are spending billions of dollars on new content. 

3. Negative free cash flow

Netflix's operating margin contracted year over year, from 14.4% to 8.2% in Q4, as it ramped up its production of new content again. That wasn't surprising and topped Netflix's previous forecast of 6.5%.

However, Netflix's free cash flow (FCF) also turned negative again after intermittently turning positive throughout 2020:

Source: Netflix. FCF = Free cash flow.

Netflix is still sitting on $6.03 billion in cash and equivalents, but rising inflation -- which reduces the value of its future cash flow -- highlights its negative FCF as a major weakness. Higher interest rates, which need to kick in to tame inflation, will also increase Netflix's borrowing costs for funding new content.

Netflix management said it believes it can maintain an operating margin of 19% to 20% in 2022 and generate a positive FCF for the full year. That forecast sounds healthy, but it could be very difficult to achieve as its revenue growth decelerates and its competitors ramp up their spending and aggressive promotions.

4. A difficult geographic balancing act

Netflix gained paid subscribers across all four of its main geographic regions in Q4: the U.S. and Canada (UCAN), Asia-Pacific (APAC), Latin America, and Europe, the Middle East, and Africa (EMEA).

However, its APAC and EMEA regions are still growing much faster than its UCAN and Latin American regions. To gain more users across those regions, Netflix has cut its prices in promising markets like India. At the same time, it's raising its prices in the U.S. and Canada.

That balancing act is risky since Netflix could alienate its higher-revenue users in the U.S. and Canada with price hikes while failing to recoup those losses from its lower-revenue users in India and other overseas markets.

That strategy also exposes Netflix to tougher currency headwinds as the U.S. dollar strengthens against other foreign currencies. Netflix already expects forex headwinds to reduce its revenue by about $1 billion in 2022 -- nearly 3% of its estimated overall revenue. 

5. The stock still isn't a bargain

Analysts expect Netflix's revenue and earnings to grow 15% and 16%, respectively, this year. However, its stock still looks a bit pricey relative to those growth rates at 31 times forward earnings.

By comparison, Meta Platforms, Apple, and Alphabet -- three of Netflix's FAANG peers -- all trade at less than 30 times forward earnings.

It might be safer to invest in those three tech giants, which are better diversified than Netflix and face fewer direct competitors, as rising interest rates shake out the tech sector's wobblier stocks.

Should you ignore these red flags?

Netflix has been a great growth stock over the past two decades, but it could face a lot of tough headwinds this year. It might eventually rebound over the long term, but investors shouldn't ignore these five red flags, which all indicate its precipitous decline will continue before new buyers swoop in.