The S&P 500 has risen nicely this year, climbing 12%. But some stocks have soared much more. One of them is Netflix (NFLX 4.17%). The streaming services stock has skyrocketed higher, earning shareholders a 44% gain year to date. While Netflix investors are likely happy with the year-to-date gain, such a big move prompts an important question. Is the stock a buy, sell, or hold after such a huge run-up?
Before we dig into whether or not shares look attractive today, let's first review how we got here. It's been quite a journey for Netflix shareholders over the last few years.
A volatile stock and a successful new product
If you think Netflix's 44% year-to-date gain is good, try zooming out to a 12-month look at the stock. Over the trailing 12 months, shares have more than doubled, rising about 108%. But here's what's even more wild: Even including this staggering gain over the last 12 months, shares are still down a total of 30% since the beginning of 2022.
Here's what happened.
In 2020, 2021, and some of 2022, Netflix seemed invincible. Subscriber growth was soaring, revenue was soaring, and operating margin was expanding. But the stock plummeted in 2022 as investors realized that the growth rates Netflix saw due to more people staying at home during the COVID-19 pandemic were quickly coming down to earth. Total paid subscribers in 2022, for instance, rose just 8% year over year.
Meanwhile, revenue increased only 6% and earnings per share fell 11%. While investors were aware that the tough comparisons the company faced due to consumers staying at home more in 2021 would eventually fade into the background and higher growth rates would likely emerge, such a sharp and sudden pullback in earnings had investors questioning the stock's premium valuation.
But optimism started growing for the stock in mid-2022 when the streaming service company said it was going to launch an ad-supported tier on its platform. This move, of course, would add an entirely new revenue stream. Upbeat sentiment for the stock has grown since then as Netflix has revealed that its ad-supported tier is doing very well. Adding to the optimism, Netflix's growth rate in paid subscribers ticked higher in the first quarter after a string of consecutive quarters in which the growth rate was decelerating.
So, the company's recent execution does deserve a higher stock price. But the question is whether or not shares have appreciated too much.
Netflix stock valuation
Today, Netflix stock has a price-to-earnings ratio of 45. A premium valuation like this prices in substantial earnings growth for years to come. Fortunately, analysts are expecting exactly this. On average, analysts expect Netflix's earnings per share to increase at a rate of 22% annually over the next five years. But the problem is that Netflix's valuation is so robust that growth like this is already priced in. For this reason, it may be wise to view Netflix stock as a hold today rather than a buy.
One reason to be cautious about the stock is that it costs billions of dollars every year for companies to produce good content. In Netflix's case, it spends around $17 billion annually on content. High content costs like this are a risk because it's difficult to predict how much it will cost to produce good content five to 10 years from now. In addition, there's always a risk that some expensive content could flop. These are problems that have plagued the movie and TV show industry for years.
Of course, if Netflix's ad-supported tier grows faster than expected, helps offset content costs, and brings in materially more profits, there's a chance that the company could outperform expectations. This is why the stock is arguably a hold and not a sell.
