3 Red Flags From Netflix's Q1 Report, and What They Mean for Investors

Is the glass half-full, or half-empty? The answer largely depends on what you prioritize as an investor. Streaming giant Netflix (NFLX -0.31%) fell short of last quarter's subscriber and revenue growth estimates when it recently reported results, but the company topped earnings expectations for the three-month stretch ending in March, and it generated a whopping $2.2 billion worth of cash flow.

The stock's slump following Tuesday's post-close release of its first-quarter figures indicates most investors are seeing the glass as half-empty.

And these sellers may be on to something. Looking beyond the numbers usually featured in headlines suggests Netflix is facing an even tougher future than the market suspects. Three red flags in particular stand out. Here's a closer look.

1. Most subscriber growth is coming from its least productive markets

Netflix added 1.75 million paying customers last quarter, versus forecasts of 1.2 million. Seems like a win, right?

Alas, the bulk of this subscriber growth came from the market that generates the lowest amount of per-user revenue -- namely, Asia-Pacific, where Netflix picked up 1.46 million of last quarter's 1.75 million customer additions. These subscribers are paying an average of $8.03 per month as of Q1, which is up slightly sequentially, but down on a year-over-year basis. In the United States and Canada, where the average customer now generates revenue of $16.18 per month, Netflix only garnered 100,000 new subscribers.

Netflix's Asia-Pacific region customer metrics

YOY = year-over-year, F/X = foreign exchange rates. Data source: Netflix.

And this average revenue per user figure for its international operations could worsen before it improves. Netflix dropped its prices in more than 30 countries in late February, according to The Wall Street Journal, with its price being halved in a handful of markets. We've yet to see a full quarter's worth of these newly lowered prices.

2. Rising costs are eating into profits

Take the first-quarter sales shortfall with a grain of salt. Revenue of $8.16 billion just barely missed the average analyst forecast, but was still 3.7% higher than the top line from the comparable period a year earlier.

Similarly, don't be too impressed by Netflix's earnings beat. The streaming pioneer earned $2.88 per share versus estimates of $2.86. Though it exceeded expectations, that's well down from the year-ago figure of $3.53 per share.

And the profit decline isn't just the result of some unfortunate accounting rules. It reflects a 12% increase in the company's cost of revenue, or the money it spends to either make or license video content available to subscribers. In other words, it's money that has to be spent. Plus, it's not likely to be dialed back in a big way anytime soon. Netflix has earmarked $17 billion for content in 2024, similar to this year's budget. Last year, the company spent just a hair under that amount on programming.

Data source: Thomson Reuters. Chart by author. Figures are in millions of dollars.

More scale will help. Whether 100 million subscribers watch a movie or 200 million people view it, the cost to film it is the same. Subscriber growth is slowing to a crawl, though, and Netflix's overall average revenue per user isn't exactly on fire, either. The company may have to eventually spend more on content to rekindle real revenue and subscriber growth.

3. Viewers losing interest

Last but not least, Netflix's appeal seems to be waning. Consumers are watching relatively less Netflix and viewing relatively more competitors' programming...at least in the United States. But the odds are good the same is happening overseas as well.

Netflix is still the king of domestic streaming, to be clear. Using Nielsen's data from March, the company reports it accounts for 7.3% of all U.S. television time. That's second to the TV-time leader, Alphabet's YouTube, but bear in mind YouTube's 8% share also includes its cable TV service, YouTube TV, which has 5 million subscribers.

What's not being highlighted is that as of December, Netflix's share of U.S. streaming time was 7.5%. In the middle of last year, that figure stood at 7.7%. Notably, newcomers like Tubi, Peacock, and Warner Bros. Discovery's HBO Max are doing the most damage to Netflix's reach.

It's not the end of the world. The streaming market itself is getting bigger, so it's conceivable Netflix is still delivering net watch-time growth. To see the streaming giant lose share by any measure, however, points to the potency of other streaming competitors.

Take the hint(s)

Don't read too much into the message. Netflix is the only major streaming platform provider that's actually profitable. It's also one of the most loved streaming services; most domestic consumers that pay for more than one streaming service typically pay for access to Netflix and something else. It's hardly facing an existential threat.

This is a company, however, that's historically been able to dominate the streaming market and continue to expand at will. And its stock has been priced as such. Now things are changing. The king of streaming isn't just facing more potential threats to its dominance. Netflix is showing subtle but clear signs of waning pricing power and slowing growth.

Current and would-be investors can't afford to price this stock as richly as they have in the past, even if analysts' outlooks for this year and the next are optimistic. Not even the company's guidance for the quarter now underway is as upbeat. Shares are down following Tuesday's post-close Q1 earnings release for a reason.

Take the hint. This is not a no-brainer invitation to buy Netflix stock.