It's no surprise that Netflix (NFLX -3.92%) shareholders have relentlessly focused on one metric above all others -- subscriber growth. When the streaming giant lost 1.2 million customers in the first six months of 2022, it hurt investor confidence in the company's growth story. But their worries were eased when Netflix reported that it had added a better-than-expected 7.7 million members in the fourth quarter. The stock was down more than 70% at one point last year, but it's up 84% since then, mimicking the trend with subscriber numbers.
But now that Netflix is hitting a new phase in its lifecycle, one characterized by financial optimization rather than the pursuit of monster growth, shareholders ought to start focusing on another key metric. In fact, we are seeing Netflix hit a major milestone. Does this mean now is the right time to buy shares of the streaming leader?
Binge-watching the cash machine
Throughout most of the past decade, Netflix was able to achieve impressive growth by investing tens of billions each year in licensed and produced content to attract an ever-growing number of viewers. This was the right strategy, in part due to the Federal Reserve's loose monetary policy and favorable capital markets. The question, however, was whether Netflix would ever be able to achieve the ultimate purpose of an enterprise, which is to generate positive free cash flow (FCF).
Netflix generated $1.6 billion in FCF in 2022, a notable improvement from its loss of $159 million in 2021. And the management team expects the business to produce $3 billion of FCF this year, a result that shareholders should cheer. Because of its huge scale, with 231 million subscribers and 2022 revenue of $31.6 billion, the business is now able to leverage its size to start producing free cash on a consistent basis.
This could prove to be a critical turning point for a company that has historically been known to burn through lots of cash in pursuit of growth. Even more noteworthy is that Netflix is hitting this milestone of positive FCF at a time when other streaming services are struggling to achieve profitability. It's a sign the business is in a much stronger financial and competitive position than its rivals.
Always consider the valuation
Netflix is reaching this major milestone at a time when its stock has been under immense pressure. From the all-time high of $691.69 that it hit in November 2021, shares are now down by about 56%. High inflation, rapidly rising interest rates, and general macroeconomic uncertainty have been headwinds for stock prices. Because of this negative sentiment, Netflix is trading at a price-to-earnings ratio of under 31, well below its three-year and five-year average valuations.
However, it might be more illuminating to look at Netflix's valuation relative to its FCF. Based on 2023's projected FCF of $3 billion, Netflix's stock sells at a multiple of about 45. That doesn't scream value right away, but if we look out a few years, it starts to look more attractive. According to Wall Street analysts' consensus estimates, Netflix is expected to generate $9.6 billion of FCF in 2027, representing a compound annual growth rate of 42.8% from 2022. This means Netflix's current market capitalization is about 14 times its projected 2027 FCF figure. That valuation looks way more compelling.
To be clear, these are just estimates, and a lot can happen over the next five years. Most notably in Netflix's case, there is intense competition in the streaming landscape. This could adversely impact the business by making content more expensive to license and produce. And a crowded industry will not only make it much more difficult for Netflix to continue adding subscribers at a healthy clip, it will also test the company's pricing power.
Nonetheless, it's refreshing to see Netflix begin to prioritize its financial health, especially after a period of time when investors couldn't get enough of unprofitable businesses. For those looking to invest in streaming stocks, Netflix deserves a closer look.
