Netflix's (NFLX -0.63%) total paid subscriber count stood at a commanding 221.8 million in the fourth quarter, but investors are concerned over slowing growth. The stock is down 27% over the last year, as subscriber growth decelerated each quarter from 21.9% at the end of 2020 to 8.9% in the most recent quarter.
On the flip side, Netflix's higher profit margin means the stock is offering better value at these lows. On a price-to-earnings (P/E) basis, Netflix is cheaper than it's been in over a decade.
Still, valuation alone doesn't make a stock a buy. Investors want growth when they invest in Netflix, but they shouldn't worry. Concerns over slowing growth are overblown, judging by the rapid growth in smart-TV adoption.
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Netflix's addressable market is massive
It's estimated that 85% of Netflix users engage with the service on a TV, according to Leichtman Research Group. The remaining minority access Netflix streams through mobile devices and via desktop or laptop computers. That number lends greater importance to another finding from Strategy Analytics that shows global smart-TV penetration is rapidly growing.
In 2020, there were an estimated 665 million households with a smart TV. That number alone might suggest a large enough market for Netflix to keep growing, except for one problem. It's estimated that nearly half of all Netflix users watch without paying for membership by sharing accounts with friends or family members.
So Netflix's reported subscriber count significantly underestimates the total number of users engaging with the service. If Netflix's total users are bumping up against the number of households with smart TVs, that might explain why subscriber growth is slowing. But there's more to the story.
Strategy Analytics also shows that smart-TV adoption is rapidly growing. The global penetration of smart TVs is expected to double to 1.1 billion by 2026. This estimate dovetails with the growth in broadband internet speeds, where Cisco Systems expects internet access to reach an additional 1.4 billion people from 2018 through 2023.
Netflix has previously mentioned that its total addressable market outside of China is 800 million households. All these numbers come together to suggest that Netflix still has a long runway of growth.
Netflix stock offers better value
The next 200 million will be more difficult to gain than the first 200 million subscribers. Nonetheless, investors are not being asked by Mr. Market to pay for high annual growth right now.
Five years ago, Netflix traded at an astronomical P/E ratio of over 300 and a price-to-sales (P/S) ratio of 7. It now trades at a P/E of 36 and a P/S multiple of 6.2. Lower valuation multiples imply lower expectations for growth.
NFLX P/S ratio. Data by YCharts.
Underpinning the value in Netflix right now, the company has finally reached a solid financial footing where it doesn't need to issue new debt to support content production. It ended 2021 with a negative $154 million in free cash flow, consistent with management's guidance to roughly break even on this profitability metric.
Management expects to produce positive free cash flow in 2022, which will enable the company to start paying down its $15.5 billion in gross debt, while still producing new shows, films, and mobile games offered through the Netflix app.
Sometimes stocks collapse for good reasons, such as when a business is struggling to generate any growth at all. But the recent fall in Netflix's share price seems to be one of those times where the market is extrapolating a recent deceleration in growth and ignoring the abundant opportunities for the company.
Given its large addressable market, Netflix can reaccelerate its subscriber growth. There are still hundreds of millions of households to gain, and Netflix is turning the corner on its finances to build the content library necessary to win them over. That makes the stock a great buy right now.
