Once upon a time, I was a Netflix (NFLX -1.51%) shareholder. But then I soured on the in-house content creation strategy, versus licensing content from existing studios.

The content-creation move was necessary to ensure that it wouldn't be dependent on its rivals. However, creating TV shows and movies is expensive, and has only become more expensive in recent years as other studios scrambled to emulate Netflix's strategy and filled up their services with new titles.

The company hasn't been all that profitable on this journey (on a free-cash-flow basis), so it resorted to funding its content strategy with debt

Business model aside for a moment, I'm still not buying Netflix stock headed into 2023 even after a massive sell-off this past year. Profits are thin, the valuation is high, and growth is slowing significantly. I'd exercise caution after a rally from multiyear lows this last summer.  

Is Netflix really a cheap stock?

Back to my hang-up on the business model. Netflix enjoyed fabulous success as a disruptor of the status quo for many years. But a lack of robust profitability is finally catching up with it, thanks to the bear market of 2022. 

On the surface, it appears Netflix is just fine. Shares trade for 25 times trailing-12-month earnings per share (EPS). However, this is due to boring accounting stuff. Basically, the company expenses the content it curates over the course of time (for most of its TV shows and movies, over the course of four years or less).

This is the effect that shows up in net income (and the subsequent EPS valuation metric). Meanwhile, actual cash outflow occurs immediately. This is the reason for the disconnect between net income and free cash flow (FCF), the latter being a more accurate measure of a company's ability to generate actual cash profit.

NFLX Free Cash Flow Chart

Data by YCharts. TTM = trailing 12 months.

Granted, as Netflix has reached massive global scale and its earliest slate of content is now paid for, FCF has turned positive again and is beginning to converge with net income. (The jump in FCF in 2020 and early 2021 was an anomaly because video production came to a sudden stop during lockdowns, and so the company stopped paying up for content.)

It's a thin profit margin, though -- an FCF margin of just 2.3% -- over the last year. And what of net income? It's set for a big dip, too, as Netflix struggles with slowing growth and an historic run-up in the U.S. dollar (which lowers the value of international sales and lowers profit margins). 

Management expects revenue to increase about 1% in the fourth quarter of 2022. The resulting EPS outlook of just $0.36 in the quarter would be down from $1.33 from last year. This  exchange-rate headwind is expected to persist into 2023. Netflix's profit profile just isn't making the cut right now. 

Lots of problems for an entire industry

The consolation prize here is that Netflix isn't alone. Even mighty Disney (DIS -1.08%) -- my horse in the media and entertainment race -- is struggling to monetize its streaming service properly. Turns out, even at incredible scale with a couple of hundred million subscribers worldwide, streaming TV is a tough business to crack.

Pair that with persistently slow box office attendance for a few years running, and it's looking like the movie business just isn't the lucrative bet it used to be.

As media companies wade through current issues like the strong U.S. dollar and a possible recession in 2023, I still see Netflix at a long-term disadvantage. It doesn't have the vertically integrated model that Disney has, able to pull on different entertainment outlets like theme parks and broadcasting.

That could change (like the current rollout of its advertising-based subscription tier), but in the meantime, Netflix isn't exactly operating from a position of strength: again, low profit and slower growth, and not exactly a clean balance sheet for a techie business. Cash and short-term investments were $6.1 billion, offset by debt of $13.9 billion.  

I'll emphasize again that Disney and other media empires are deeply flawed as well. But as time goes on, Netflix is beginning to look more and more like the rest of the pack. Shares aren't cheap, and profits are getting ready to dip further. I believe there are better ways to invest in an evolving leisure and entertainment industry right now.