Just a few years ago, Netflix's (NFLX -9.09%) big content spending meant free cash flow was consistently negative. Fast forward a couple of years, and the company is measuring this cold, hard cash in the billions. The streaming-service specialist is at an inflection point when it comes to profitability -- and this inflection point will likely be even more evident going forward.
Generating positive free cash flow is likely music to shareholders ears. It's been about 10 years since the company embarked on an aggressive strategy to invest in original content. A decade later, the once-risky strategy is now looking quite genius in hindsight.
The company's content library now features many must-see films and shows, some of which have global appeal. Better yet, Netflix has now achieved the necessary scale to sustain its current output of high-quality content profitably.
Here's a close look at Netflix's profits, despite continued aggressive spending on content.
Free cash flow is soaring
Netflix management revealed in its recent fourth-quarter update that it generated a total of $1.6 billion in free cash flow in 2022. This level is up from approximately breakeven free cash flow in 2021 and negative $3.3 billion in 2019, highlighting how this is an inflection point for the company. Notably, Netflix's free cash flow was $1.9 billion in 2020, but this was because many film studios paused production as the world dealt with the rapid spread of COVID-19.
Looking to 2023, management is guiding for record free cash flow of "at least $3 billion," assuming no material swings in foreign exchange.
Driving home just how impressive this outlook is, it comes even as the company plans to maintain its monstrous annual budget for content spending at around $17 billion. Even more, Netflix is ramping up a new advertising business, requiring new hires, technology, and incremental product-development costs.
Shares are priced for near perfection
While this inflection in profitability is good news for Netflix shareholders, the stock's move higher in recent months may have already priced in Wall Street's rosy outlook for the company. Netflix's $161 billion market capitalization at the time of this writing is equal to about 53 times the company's expected free cash flow this year. Even if 2024 free cash flow rose to $4 billion, the stock currently trades at 40 times this expected free cash flow.
Fortunately, Netflix's launch of an ad-supported tier helps mitigate some of the risks to owning the stock, so the stock deserves a premium valuation. Management recently said it expects its advertising business to grow to more than 10% of revenue in the coming years, making it a big contributor to both top- and bottom-line results. This new revenue stream gives Netflix a larger addressable market than the company would have if it had remained a subscription-only streaming service.
Nevertheless, investors should remember that the stock is already pricing in strong growth for years to come. While it's good to see the company hitting an inflection point in profitability, it doesn't necessarily make the stock a bargain at this level.
