Netflix's (NFLX -0.51%) business has certainly hit a rough patch, and that's reflected in the stock price. In late 2021, the shares were at nearly $700 but now sell for about 40% of that level.
The company's once-bright growth prospects have seemingly waned due to a variety of reasons, including increased streaming competition from the likes of Apple and Walt Disney. To its credit, management hasn't stood still and has taken steps to outdo these other services.
Will these be enough to increase Netflix's revenue and profitability growth? It's an opportune time to dive into Netflix's fundamentals to see if it's time to buy the shares or take a pass.
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Subscriber count
Netflix lost subscribers for a couple of straight quarters. It ended 2021 with 221.8 million paid streaming subscribers, which fell to 220.7 million at the end of June. This reversed course in the third quarter, which ended with 223.1 million. Management expects to finish 2022 with 227.6 million subscribers.
Starting in 2023, the company plans to charge account holders extra fees for sharing passwords, which could result in a short-term gain of additional subscribers.
Although Netflix's revenue grew by 5.9% to $7.9 billion, operating expenses outpaced that rate, and the company's operating income shrank by 12.6% to $1.5 billion. Its operating margin contracted by 4.1 percentage points to 19.3%, but management blamed this almost entirely on foreign-currency translations.
Nonetheless, while it's easy to feel pleased by third-quarter results and the optimistic view on subscriber count, the road ahead seems bumpy.
Offering an inferior service
Netflix has been regularly raising prices, including earlier this year. At that time, it increased the monthly rate by $1 to $1.50. In response to pushback, the company has been rolling out a lower-priced, ad-supported subscription.
This plan will have 20% to 40% lower prices than non-ad subscriptions. However, viewers will have the inconvenience of watching commercials. New movies will only have ads at the start of the show, but subscribers will also have to endure them during older content.
Additionally, subscribers to the ad-supported service won't have access to the full lineup of content. It's true that many other streaming services, like Disney's Hulu and Disney+, Warner Bros. Discovery, and Apple either offer or are contemplating a lower-priced ad service. However, that means the competition for cost-conscious viewers and, hence, ad dollars has intensified.
Rich valuation
While Netflix's sharp stock drop this year has caused the price-to-earnings ratio (P/E) to fall to 26 from 60, it remains higher than the S&P 500's 21. Given Netflix's slowing revenue growth and more intense competition, that seems like an expensive valuation.
While it's tempting to invest in Netflix, the once high-flying stock has fallen to Earth. It's hard to imagine the company resuming that kind of growth as viewers face many choices of high-quality content. Diminishing the viewer's experience doesn't seem like the answer.
For those who are contemplating an investment in Netflix's stock, I advise taking a pass.
