In 1997, Reed Hastings co-founded Netflix (NFLX 1.71%). Twenty-six years later, he is stepping down. Under his tenure, anyone who invested $10,000 in Netflix stock at its initial public offering now has nearly $3 million.
This is an unbelievable run under a visionary CEO, but it might leave investors wondering if they should also head for the exits. So let's find out if Netflix stock is worth owning despite losing Hastings.
Profits are shrinking while cash flow is increasing
Hastings isn't completely gone from Netflix -- he's transitioning to the role of executive chairman of the board. Essentially, this is more of an oversight, big-picture role rather than day-to-day operations. It's also what many founders choose to do when they think it's time to move on.
However, he leaves Netflix in a precarious place for the co-CEOs to take over.
In the fourth quarter, Netflix's revenue growth slowdown is still occurring, with sales only rising 1.9% over last year's total. However, management expects 3.9% growth in the first quarter of 2023 -- better than a slowdown but nothing significant. Additionally, Netflix's margins are creeping lower.
In 2021's Q4, Netflix's operating margin was 8.2% -- that number fell to 7% in Q4 2022. Historically, Q4 has been a quarter of low operating margins for Netflix, but a margin drop isn't a good sign. Furthermore, Q1's expected operating margin is 19.9%, down from 2022's 25.1%. In both cases, the slow revenue growth didn't offset the margin pressure, so Netflix's operating income also decreased (or is projected to decrease).
However, the narrative flips when you look at it from a free cash flow (FCF) perspective. Netflix produced $332 million in FCF in Q4, compared to a $569 million loss last year. So, how did Netflix increase its cash flow while decreasing its earnings? Look no further than stock-based compensation.
In Q4 2021, Netflix paid its employees $99 million in stock. However, that number rocketed 56% higher in a single year to $154 million in Q4 2022. This echoes what happened throughout 2022, as Netflix paid 43% more stock to its employees than it did in 2021.
So while management is pumping up shareholders with its guidance for $3 billion FCF in 2023, investors need to understand that it's funding this by issuing new shares, which dilutes their position.
However, management doesn't think its operating margin will stay at these levels in 2023.
The stock is expensive for its low growth rate
During its Q4 earnings call, management indicated it should see its operating margin increase throughout 2023. New products (Netflix's ad tier and paid sharing) and increased cost discipline are some drivers for this.
That's great news for investors, but I will need to see it to believe it -- the streaming landscape is highly competitive now.
At a 36 price-to-earnings ratio, Netflix isn't a cheap stock. Couple that with a relatively slow revenue growth rate, and I don't see the valuation making much sense. Furthermore, the ad tiers and paid sharing services will likely provide a one-time boost in 2023, creating revenue growth issues in 2024.
While many see Hastings riding off into the sunset, I don't see it that way. I think he is choosing an excellent time to leave, as the business could get tricky in 2023 and 2024.
I don't own the stock and have no plans to purchase any shares, but with the stock's high valuation and low growth rate, shareholders need to watch this stock closely. Plenty of other companies are growing faster and are valued at lower levels than Netflix -- I think those are a much better place for your money over the next three to five years.
