Spurred by weaker-than-expected subscriber guidance for the first quarter, Netflix (NFLX -3.92%) shares, down 37% in 2022, have been getting crushed in recent months. And investors have started to question if the market-beating returns they've become accustomed to are now a thing of the past.
For what it's worth, Netflix is still the clear leader in the streaming industry. The business generated $29.7 billion in revenue last year and now counts 222 million paid members. And while the future might not resemble the stellar historical growth we've seen, the company still has an opportunity to execute on management's goal to entertain the world.
Is a 13-figure valuation realistic for Netflix by the end of the decade? Let's look at what needs to happen for the company to reach the exclusive $1 trillion club.
It's all about subscriber growth
Netflix's success depends on its ability to continue to add tens of millions of customers each and every year. This is not breaking news. Chief financial officer Spencer Neumann recently highlighted a path to one day amassing 500 million subscribers if the business can reach the same level of penetration internationally that it has in the U.S.
In 2021, 93% of Netflix's new members came from outside the U.S. and Canada (called the UCAN region). And this trend is likely to continue in the years ahead. That's because the domestic market is showing signs of maturity, while other regions, like Europe, Middle East, and Africa (EMEA), Latin America (LATAM), and Asia-Pacific (APAC), have a long runway to increase customers as broadband internet becomes more available.
Let's assume that Netflix will have 500 million subscribers by the end of 2030, which equates to roughly 31 million new members annually and is in line with management's ultimate target mentioned earlier. I think it's totally possible for Netflix to generate $100 billion in annual sales at that time. That means 15% revenue growth per year through 2030, far slower than the past decade.
Image source: Getty Images.
Netflix's financial profile will improve
At this massive scale, the company's financial situation will be better than it is today, as margins are sure to significantly expand. While Netflix's biggest expense category, creating content, is a variable, it's still an expense that can be predictably budgeted beforehand by management as a fixed percentage of total revenue. Yet at the same time, it doesn't cost anything to service additional subscribers. Put differently, the business benefits tremendously from achieving greater scale.
The net income margin went from 2.1% in 2016 to 17.2% in 2021. I don't know what the long-term profit margin looks like, but management expects the operating margin to expand by 3 percentage points annually over any multiyear stretch. While this is different from the net margin, we can probably predict a similar trajectory with the bottom line's growth. Let's say by 2030, Netflix carries a 40% profit margin.
With $40 billion in net income in 2030, Netflix's price-to-earnings (P/E) ratio would have to be 25 to get us to a $1 trillion market cap. That's lower than Netflix's current P/E ratio of 34, probably accurate given that the company's growth outlook would be much more limited at that time, and the business would be considered mature, warranting a lower multiple.
Is $1 trillion likely?
Excluding the impact of share repurchases, a $1 trillion market cap by 2030 implies an annualized return of 23% for Netflix investors. That would almost certainly beat whatever the S&P 500 does during the same time. For comparison's sake, over the past 10 years, Netflix has generated an average yearly return of almost 37%, so the projected future slowdown seems somewhat reasonable.
There are additional growth levers management can lean on, like gaming and maybe live sports, that could provide upside to revenue potential. And this can definitely increase the chances that the business eclipses a 13-figure valuation.
I think Netflix has a legitimate shot at becoming a $1 trillion business. But whether it happens by 2030 or later is anyone's guess. Nonetheless, I think the stock makes for a fine investment.
