Netflix's (NFLX -3.92%) stock price plunged about 60% this year and erased nearly four years of gains. The bulls fled as the streaming video giant's subscriber growth stalled out and its operating margins declined. Challenging comparisons to its pandemic-era growth, intense competition, and rising interest rates further exacerbated that sell-off.
But after that painful rout, Netflix's stock looks historically cheap at 21 times forward earnings. Could this struggling stock stage a massive comeback in the near future? Let's review the bear and bull cases to decide.
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What the bears will tell you about Netflix
The bears believe Netflix's heyday is over. Over the past few years, formidable competitors like Walt Disney (DIS 0.18%), Amazon, Apple, Warner Bros. Discovery (WBD -0.71%), Paramount Global (PARA -0.47%), and Comcast (CMCSA -0.37%) have saturated and carved up the streaming video market.
Netflix's number of paid subscribers rose 22% to 203.7 million in 2020 but only increased 9% to 221.8 million in 2021. It ended the second quarter of 2022 with just 220.7 million paid subscribers. Disney ended its latest quarter with 221 million subscribers across all its streaming services (Disney+, Hulu, and ESPN+), which represented 27% growth from a year earlier. Therefore, Disney's streaming subscriber count now eclipses Netflix's.
To keep pace with Disney and its other competitors, Netflix needs to license more content and produce more original shows and movies. That's why it expects its operating margin to decline from 20.9% in 2021 to about 19%-20% this year. As Netflix struggles to gain new subscribers and ramps up its spending, analysts expect its revenue to grow just 7% this year as its earnings decline 10%.
Those anemic growth rates make Netflix more comparable to a traditional media company than a growing tech titan. Yet Netflix isn't valued like a traditional media company yet. Disney has a forward price-to-earnings ratio of 18, while Comcast and Paramount trade at eight and 10 times forward earnings, respectively. Therefore, Netflix's stock could still be overvalued at more than 20 times forward earnings.
Over the long term, Netflix management believes the company can gain more subscribers by launching a cheaper ad-supported tier. However, most of its competitors -- including Disney, WBD's HBO Max, Paramount+, and Comcast's Peacock -- have already beaten it to the punch with similar ad-supported platforms. In addition, the ongoing macro headwinds could make it difficult for Netflix to generate enough advertising revenue to offset those lower subscription fees.
What the bulls will tell you about Netflix
The bulls believe the streaming race isn't a zero-sum game. There could still be plenty of room for Netflix, Disney, HBO Max, and others to expand without trampling each other. Netflix could also continue to churn out surprising hits -- like Stranger Things, Squid Game, and Bridgerton -- by crunching its AI algorithms to create fresh original content.
Investors should also remember that Netflix is more profitable than its newer streaming challengers. For example, Disney's direct-to-consumer segment, which houses its streaming services, posted a staggering operating loss of $2.54 billion in the first nine months of fiscal 2022, which was more than double its operating loss of $1.05 billion a year earlier. Therefore, Netflix's growth might be cooling off, but its early mover's advantage, scale, and established slate of original content could help it hold off its challengers while generating much higher profits.
Netflix expects to end its two-quarter streak of sequential subscriber losses, which was partly caused by the Russo-Ukrainian war, by gaining about a million subscribers in the third quarter of 2022. That stabilization could give it a firm foundation to launch its ad-supported tier this November.
If that launch coincides with a broader recovery across the ad market, which has been under pressure throughout most of this year, Netflix's growth could accelerate again in 2023. Analysts expect that recovery to be moderate, with 8% revenue growth and 7% earnings growth, but it could easily clear those conservative estimates if it launches new hit shows, gains more subscribers, and attracts legions of eager advertisers to its platform.
Which argument makes more sense?
Netflix won't be rendered obsolete anytime soon, but its high-growth days are likely over. Its growth could stabilize after it launches its ad-supported tier, but its valuation already reflects those potential improvements. Simply put, I don't expect Netflix's stock to decline much further, but I also don't think it will bounce back toward its all-time high anytime soon.
