Is Netflix Stock a Buy After Subscriber Number Surprise?

This year has been tough for Netflix (NFLX 1.74%) investors. In the first quarter, after announcing its first subscriber loss in more than a decade, the stock shed a third of its value overnight. To make matters worse, Netflix management predicted more pain to come and forecast the loss of an additional 2 million paid subscribers. In the wake of that surprisingly weak showing, Netflix stock fell as much as 77% from its high reached last year.

It appears there's light at the end of the tunnel -- and it may not be a train. All eyes were on Netflix's subscriber numbers when the company reported its second-quarter results Tuesday after the market close -- which were far better than expected. In the wake of this whipsaw performance, is Netflix stock a buy?

First, the numbers

By a wide variety of metrics, Netflix's growth was stronger than investors had expected. The company generated second-quarter revenue of $7.97 billion, up 8.6% year over year, just missing analysts' consensus estimates of $8 billion. That requires context, however, as the strong dollar obscured growth that would have climbed 13% if not for exchange rate headwinds. Profits were also robust, with earnings per share (EPS) of $3.20, easily eclipsing the $2.95 expected by investors.

The focus was on subscriber numbers, which were also better than expected. Netflix reported a loss of 970,000 subscribers quarter over quarter, far better than the loss of 2 million it had predicted. In fact, its subscriber accounts grew 5.5% year over year. Perhaps more importantly, Netflix reported an increase in the average revenue per membership, which edged 2% higher, or 7%, excluding exchange rates. This illustrates that the company still has pricing power, though some would argue that strength has diminished in recent years.

Plenty of irons in the fire

While investors continue to focus almost solely on subscriber numbers, Netflix has a number of catalysts that could propel the stock to new heights.

The biggest potential driver is the lower-priced, ad-supported tier Netflix plans to roll out in early 2023. Just last week, the company announced it had chosen Microsoft (MSFT -2.45%) as its "global advertising technology and sales partner." Netflix is reportedly working on "a premium, better-than-linear TV brand experience for advertisers." Some estimates suggest the ad-supported tier could boost the company's revenue by more than 20%. 

Then, there are the freeloaders. Management estimates that there are more than 100 million viewers password-sharing and not paying for an account. The company is reportedly testing two different approaches to ultimately get these viewers to pay. The goal is to have a paid-sharing offering to roll out by next year. 

Netflix is also delving further into its cloud gaming service with the acquisition of Next Games -- the studio behind Stranger Things: Puzzle Tales -- for about $69 million. This adds to Netflix's portfolio, which now includes three studios and has grown to 24 games. Management revealed that "millions of our members play games through the service, and we are learning about what games work for different audiences." Given its recent partnership with Microsoft, Netflix's treasure trove of viewer data, and its history of successful recommendations, don't underestimate its ability to hone in on a winning strategy in gaming. 

Further, the company announced plans to acquire world-class animation studio Animal Logic, to expand and accelerate Netflix's ambitious animated film slate and production capabilities. 

Finally, Netflix continues to lean into its local-language programming, extending its lead in international markets. Even as growth dipped in the U.S. and Canada -- its most highly penetrated markets -- Netflix added new members in the Asia Pacific and Latin American segments, suggesting this strategy is bearing fruit. 

To buy or not to buy?

As with so many things, the answer won't be the same for every investor and must take into account their temperament, investing time horizon, and risk tolerance.

Those things aside, Netflix has a long and storied history of confronting challenges and adapting. There are plenty of ways for the company to reaccelerate its growth, as outlined above. Not all of them have to be successful in order for Netflix to return to serious growth mode.

There's also the question of valuation. Netflix is currently selling for roughly three times sales, the lowest valuation for the stock since early 2013. With even modest success at accelerating its growth, investors would likely rate the stock much more generously.

Finally, Netflix generated positive operating cash flow and free cash flow this quarter and expects to produce free cash flow of roughly $1 billion this year (excluding exchange rate fluctuations) with "substantial" growth in 2023. This gives the company serious financial flexibility moving forward. 

There's little question that the streaming company has challenges ahead, but given the number of catalysts and the bargain-basement valuation, in my book, Netflix is an unqualified buy to hold for the long-term.