Netflix Subscriber Growth Is Back. Time to Buy the Stock?

After two straight quarters of subscriber declines, Netflix (NFLX -3.92%) just showed that its growth story isn't dead.

The streaming giant added 2.4 million subscribers in the third quarter, better than its guidance of 1 million. That, and fourth-quarter guidance that called for another 4.5 million new subscribers, elicited cheers from the market, and the stock jumped 14.4% after hours Tuesday, following the earnings release.

Netflix grew subscribers in all four regions with particularly strong growth in the Asia-Pacific region, where it added 1.43 million new members and still has a large market to penetrate. While the return to subscriber growth provided much-needed good news for the company, that wasn't the only thing moving the stock.

Here comes advertising

Just six months after Netflix declared its intention to launch an advertising business, its ad-based tier is set to go live in early November. It will launch in 12 countries that together make up 75% of advertising spending on TV and streaming, or a $140 billion addressable market.

The basic-with-ads tier will cost 20% to 40% below the current basic plan, and will carry five minutes of advertising per hour. In the U.S., the basic-with-ads plan will go for $6.99/month, compared to $9.99/month for the ad-free basic plan.

Management said it didn't expect the ad tier to be material to fourth-quarter results since it was launching in the middle of the quarter and that it will take time to build out a base of ad-tier subscribers.

It's understandable why management would play down expectations for the new business, but it could still be a major profit driver for Netflix. Connected TV, or ad-driven streaming, is one of the most valuable forms of advertising for brands since it's targeted, video-based, and takes place on a large screen. Netflix also has a huge audience, making it an appealing partner for advertisers, and digital advertising tends to be a high-margin business at scale as businesses like Google and Facebook have shown.

The cure for password sharing

There's also another significant change coming to Netflix. After years of talking about a solution for password sharing, the company is now implementing a plan to address it. Management said it was going to offer those who use other subscribers' Netflix accounts the ability to transfer their profile into their own account. The original subscriber can then create a sub-account for them if they want to pay for them.

Netflix didn't say how much it would charge for sub-accounts, but the move should give a significant boost to its profits as the password borrowers are currently unmonetized. It's essentially a cost-free revenue stream for the company. 

For Netflix, these two changes are significant enough that the company is revising the way it gives guidance. It will no longer guide for subscriber growth, instead focusing on financial metrics like revenue, operating income, and earnings per share. That's a departure from its and Wall Street's traditional focus on subscriber growth as the most important way to judge the company's performance. 

With advertising and account sharing adding to its revenue, it makes sense to downplay subscriber growth, but the decision also seems like an admission that subscriber growth will never approach its pre-pandemic level, when the company was adding close to 30 million subscribers a year.

Is Netflix a buy now? 

Netflix avoided the worst-case scenario by posting better-than-expected subscriber growth in the third quarter and guiding for even stronger growth in the fourth.

The results make it clear that the stock was oversold following its subscriber declines earlier in the year, and it was a mistake to think that the growth story was over. Though its subscriber growth may be slower than in the past, the stock still looks undervalued even after the 14% jump, trading at a price-to-earnings ratio of 27 based on this year's expected earnings.

The company remains the leader in the streaming sector, and management said in the quarterly letter to shareholders that it believed all of its competitors were losing money. If true, that means Netflix has a significant competitive advantage over the newer streaming entrants, and the company looks set to unlock a multibillion-dollar revenue stream in advertising, as well as pad its bottom line through account sharing.

While Netflix's best growth days appear to be behind it, the upside potential from new revenue streams still outweighs the downside risk to the stock from a maturing market and new competition. It's a good time to buy the streaming stock.