Netflix's (NFLX -3.92%) recent sell-off (down 38% year to date), sparked by a weak first-quarter forecast for subscriber additions, indicates that investors have soured on the company. The powerful momentum from the pandemic, when everyone was stuck at home watching TV, has clearly faded. What's more, heightened competition from other streaming rivals has given consumers an unlimited number of viewing options at their fingertips.
So is Netflix still a growth stock? Here's why I think it most certainly is.
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Netflix wants to entertain the world
Netflix is the leading streaming service with 222 million paying customers. This level of scale, a feat attributed to the company's first-mover advantage, allows management to invest heavily in content. In 2021, Netflix laid out almost $18 billion in cash on TV shows and movies, a number that has resulted in the company's service being second to none.
According to data from Nielsen, Netflix accounts for the highest portion (6.4% in December) of TV viewing time in the U.S. among streaming services. Only Alphabet's YouTube is even in the same ballpark. Consequently, Netflix has the lowest churn rate of any streaming service out there, so if we zoom out, we find a business that still has the best product in the industry.
The question is: Just how many subscribers can Netflix ultimately have? CFO Spencer Neumann thinks this figure could eclipse 500 million. Speaking at the Morgan Stanley Technology, Media, and Telecom Conference on March 8, he highlighted how the business is roughly 60% penetrated when it comes to Netflix's share of total cable-TV households in the domestic market. If we extrapolate this percentage to the one billion connected-TV households there will be worldwide (excluding China) within the next 10 years, it's easy to see just how huge the company's opportunity really is.
Not only will Netflix's revenue, which came in at nearly $30 billion in 2021, get a boost with more subscribers, but the company's profitability will also soar. As global paid subscribers grew from 89.1 million in 2016 to 221.8 million last year, operating margin expanded from 4.3% to 20.9% over the same period. It's no wonder management expects to generate positive free cash flow starting in 2022.
Investors are fixating too much on the quarter-to-quarter volatility when it comes to Netflix's membership additions. The coronavirus pandemic threw a curveball that no business was prepared for. And while some companies benefited more than others, we are still in an extremely uncertain economic environment that unsurprisingly will lead to lumpiness in quarterly results. That's why it's best to keep your focus on the next five years or more.
Investors can take advantage of an attractive valuation
As of March 17, Netflix stock trades at a price-to-earnings ratio of 33. This is the cheapest shares have been in almost a decade, and it's a valuation that signals the market's serious lack of enthusiasm for a business that has historically been one of the best investments anyone could make. For those who believe in Netflix's prospects, despite the recent slowdown and choppiness, now is a great time to scoop up shares.
If Netflix can get back on track and resume the impressive growth we're all accustomed to, there's a possibility the business could one day be worth $1 trillion (compared to about $165 billion as of this writing). Ongoing benefits from its massive scale in the streaming industry, which should fuel expanding margins and free cash flow in the years ahead, will certainly propel the stock price.
The pessimism surrounding Netflix is at its peak, but if investors take a long-term approach, this entertainment juggernaut is a worthwhile addition to their portfolios.
