Shares of Netflix (NFLX +0.71%) have skyrocketed this year. As of this writing, the streaming TV and movie service company's shares have gained 47% year to date. This obliterates the S&P 500's approximate gain of 14% during this same time frame.
With so much momentum in Netflix's stock price, many investors are likely wondering: Can shares keep climbing higher? The short answer, of course, is "yes." But for investors asking the question with a deeper and more useful meaning behind it, the answer may not be as straightforward.
Prudent investors, for instance, are likely pondering whether the stock is still an attractive long-term investment after its recent big gains. After all, the stock's price-to-earnings ratio is now quite high at about 48. This means investors are already pricing in exceptional earnings growth for years to come.
Are shares likely to pan out to be a good investment from their current price over the next five years?
NASDAQ: NFLX
Key Data Points
Why earnings could surge
There are actually some good reasons to believe Netflix stock remains attractive at current levels. Chief among those reasons are some clear catalysts for earnings growth in the coming years. Those catalysts include:
- layoffs in 2022 that led to a leaner business
- growth in the company's new higher-margin advertising business
- efforts from management to reduce account sharing
- further international growth
- improving economies of scale
The last reason to expect strong earnings growth from Netflix in the coming years -- improving economies of scale -- is worth expanding on. Unlike in the previous decade, Netflix's annual content-spend growth has slowed in recent years. Indeed, the company has maintained an annual budget of around $17 billion for content in 2022 and 2023 -- and management expects this to remain the company's approximate budget in 2024. This is enabling Netflix to spread its content investments across a growing base of subscribers.
Paid subscribers have been growing at a rate of around 4% to 5% year over year recently, and this growth rate could accelerate in the second half of the year as the company's recent efforts to reaccelerate growth start paying off. Netflix's improving economies of scale mean each new subscriber may lead to more profits than new subscribers did in previous years.
To this end, analysts expect Netflix's adjusted earnings per share to compound at an average annualized rate of about 21% over the next five years -- a growth rate that would likely justify the stock's current valuation.
Manage risk
Thanks to a laundry list of reasons to expect strong earnings growth from Netflix in the coming years, the stock's valuation arguably remains attractive. That said, shares aren't cheap, so there's very little margin of safety built into the stock price. In other words, if unexpected challenges reveal themselves, shares could underperform since they're priced for exceptional business execution in the coming years.
Investors, therefore, should consider keeping any position in Netflix stock as a small percentage of their total assets. Good diversification could help an investor manage the risk of investing in a stock that has such strong expectations baked into the current stock price.
