Coming into its second-quarter earnings report, Netflix (NFLX -1.85%) had already been written off by much of the financial media.
The company reported a surprise subscriber decline in Q1 and then shed another 1 million members in Q2. Even after a pop on better-than-expected Q2 numbers, the stock is still down roughly 70% from its peak last fall, showing how much faith investors have lost in the stock.
While Netflix does face some challenges, that doesn't mean that the stock is a dud. In fact, the sell-off could be an excellent buying opportunity. Keep reading to see three reasons to keep the faith in the leading streamer.
1. Revenue growth is still solid
Two consecutive quarters of subscriber declines have been the focus of headlines, but even as Netflix experiences a modest subscriber decline, it's still delivering solid gains in revenue due to price hikes and year-over-year subscriber gains.
In Q2, revenue rose 9%, or 13% in currency-neutral terms as a strong dollar lowers the value of Netflix's international revenue. At 13% growth, Netflix may no longer be the hot growth stock it once was, but it's also not one of its legacy media competitors that are struggling to grow revenue as they exchange cable subscribers for streaming ones.
Investors also have to remember that the company and the entire streaming sector is facing cyclical headwinds after the boom in streaming early in the pandemic. That will eventually fade.
Q3 guidance called for a modest subscriber growth of 1 million. Again, that many not be enough to delight growth investors, but it shows the company is moving in the right direction.
2. Profits are strong
Critics have pooh-poohed Netflix's business model for burning too much cash and having an unsustainable content budget. However, the company is in a much different position than it was a few years ago. On a generally accepted accounting principles (GAAP) basis, its operating margins now hover around 20%, and management expects those to continue to increase, though not as fast as it once projected.
On a free cash flow (FCF) basis, the company is also profitable and expects to generate $1 billion in free cash flow this year. It also sees FCF margins moving closer to its operating margins as it moderates its content-spending growth.
In other words, the worst-case scenario for Netflix seems to be that it's a slow-growing, highly profitable leader in the streaming industry. That's not a bad position to be in at all, especially for a stock trading at a price-to-earnings (P/E) ratio of less than 20.
3. Advertising could be a big winner
Netflix resisted advertising for several years, but tough times have forced the company to reevaluate its business model. After announcing a plan to launch an advertising tier earlier this year, Netflix is moving quickly, partnering with Microsoft to launch by early next year.
Advertising could prove to be a big moneymaker for the streamer. It has 220 million subscribers around the world and granular data on its subscribers' viewing habits. Both of those factors make it a highly desirable platform for advertisers. Additionally, Netflix has disrupted the advertiser ecosystem in linear TV, and brands are hungry to replace that. So Netflix is a natural partner.
Netflix has also proven its ability to deliver eyeballs. In fact, in the U.S. the company had far more total minutes watched than any other network or streaming service. With 1.3 trillion minutes, it had nearly as many as CBS and NBC, the number 2 and number 3 most watched services, combined.
The company's conundrum at this point is that it excels in getting viewers to spend time with its service, but it doesn't have a way to monetize that time since users who barely watch Netflix pay as much as someone who watches it three hours a day. Advertising allows it to take advantage of that as it can sell ads according to time spent watching the service. The ad business could be stronger than expected. Hulu, which offers both ad-free and ad-based tiers, has made more in revenue per user from its ad-based tier at times, and the same could be true for Netflix.
2022 will go down as a challenging year for the streaming leader, but 2023 could be the start of an earnest comeback. With the launch of the ad tier, an expected improvement in free cash flow margin, and diminished cyclical headwinds from the pandemic hangover, Netflix is likely to be in a better position a year from now.