Netflix (NFLX -3.92%) has been facing a hypercompetitive industry in recent years as numerous streaming companies vie for viewers' attention. Shares are down 48% from their peak (as of May 25), reflecting this challenging operating environment. To spur growth, Netflix introduced a cheaper, ad-based tier, and the business is cracking down on accounts that share passwords.
Do the beaten-down shares present a potential buying opportunity? Let's look at three reasons why investors would want to buy the top streaming service stock, as well as a compelling reason to sell.
A favorable financial position
One of top reasons to like Netflix is its improved financial position. The business reported an operating margin of 18% last year, and management predicts it will be higher this year. That's a sign of a healthy business from a profit perspective.
Moreover, after generating $1.6 billion in free cash flow (FCF) in 2022, Netflix is poised to produce $3.5 billion of FCF this year. This is a tremendous achievement for a company that has burned through tens of billions of dollars annually to get to this point.
Netflix's financial situation shows that its first-mover advantage, which it gained because it pioneered the streaming industry, is starting to pay off. Smaller rivals will have a hard time catching up.
Dominating the television
Investors might also like Netflix because of its dominance in the streaming industry. According to data from Nielsen, Netflix captured 6.9% of TV viewing time in April in the U.S. Alphabet's YouTube took the top spot. But excluding the user-generated content platform, Hulu was the closest to Netflix at only 3.3%.
With the financial resources to spend $17 billion in cash on content in 2023, Netflix will be in a good position to continue releasing hit shows and movies for years to come. And this should help draw more viewer attention.
Success of the ad tier
And speaking of the cheaper, ad-supported tier, which I touched on earlier, management is seeing early success, announcing recently that 5 million subscribers are on the plan. More impressively, over 25% of new sign-ups are choosing the ad-based option.
Executives had long dismissed the idea of introducing ads because they thought it would ruin the customer experience. But with growth slowing down, Netflix needed to find ways to jump-start the business. And the early popularity of the ad tier shows that customers value having a choice based on their monthly budgets.
CFO Spencer Neumann thinks this offering could one day represent at least 10% of overall company revenue. It's certainly off to a good start.
Why investors might want to avoid the stock
Despite there being some compelling characteristics that demonstrate the quality of Netflix's business, investors should be aware of a downside risk. The sheer amount of competition in the industry today is enough of a reason to avoid the stock.
Yes, Netflix has a first-mover advantage and the massive scale to better compete in the industry. But it's no longer the only option consumers have when cutting the cord and looking for more convenient entertainment alternatives. Walt Disney, Amazon, Apple, and Warner Bros. Discovery, among many others, offer competing services that have gained traction with viewers.
More competition means growth over the next five years will likely be far slower than the past five years. Between 2017 and 2022, Netflix increased its revenue at a compound annual rate of 22%. I don't see this happening as we look out to the next few years. The business already has 232.5 million subscribers, and its most lucrative region, known as UCAN (U.S. and Canada), might be fully saturated.
Moreover, greater competitive forces will pressure Netflix's ability to keep raising prices in the future. This has been a hallmark of the company's strategy, particularly in the U.S.
Investors must decide if the positive traits carry more weight than the fierce competition in the space. This should ultimately help guide them regarding what to do with Netflix's stock.
