Netflix (NFLX 2.72%) shares crashed 25% after reporting fourth-quarter 2021 earnings on Jan. 20. While the stock has recovered a bit since then, the sudden drop appears to be due to new guidance from management. Netflix told investors to expect lower-than-average subscriber growth in Q1.
Was the fall in the price justified or was it an overreaction to the bad news? What follows is a closer look at the subscriber guidance and a calculation of the magnitude of the impact.
$800 million less than expected is a hefty sum
Netflix guided investors to look for subscriber growth of 2.5 million in its first quarter of 2022. That was much less than the market was looking for because Netflix has typically added millions more in Q1. Over the past five years, Netflix has averaged subscriber growth of 8.38 million in Q1. For Netflix to guide at 2.5 million is roughly 5.88 million below its average.
Moreover, in its most recent quarter ended Dec. 31, Netflix generated an average revenue per user (ARPU) of $11.72. The company makes more from some users in certain regions and less from others. Excluding the effects from exchange rates, Netflix increased its ARPU year over year in every region where it operates.
So taking Netflix's $11.72 in ARPU and combining it with 5.88 million fewer subscribers will result in $69 million less in revenue per month for Netflix or $827 million less annually. As Netflix had $29.7 billion in revenue in 2021, that's only a 2.8% shortfall. But given that the bulk of Netflix's incremental revenue flows to the bottom line, it becomes more notable. Netflix reported $5.1 billion in net income. If you estimate that $700 million of the $827 million flowed to net income, it would be a shortfall of 13.7%.
Was the Netflix stock price crash justified?
Overall, Netflix operates with a high degree of leverage. Its costs stay relatively the same whether it has 100 million subscribers or 200 million. Therefore, the extra subscribers add to profits and cash flow more meaningfully than if its costs were more variable. For that reason, subscriber figures hold a strong influence on the stock price.
That said, a stock price crash of 25% following its earnings announcement does look like an overreaction. Even though Netflix is pretty good at forecasting its subscriber growth, it is still just a forecast -- which is something no one has learned to do with perfection. The market has now corrected some of that overreaction.