Not long ago, Netflix (NFLX -0.63%) had investors very worried. Revenue and membership growth decelerated rapidly in 2022 and eventually hit low-single-digit levels. Also weighed down by a sell-off in tech stocks, the stock cratered, falling more than 50% in 2022. However, as Netflix started rolling out its advertising business and began cracking down on users who accessed the service without paying by logging into someone else's account, the narrative quickly turned positive. Shares have risen more than 80% since the beginning of 2023, and the stock is up 50% over the trailing 12 months.
With such incredible gains in the rearview mirror, some shareholders may be debating what to do. Is it time to sell and take profits, or is the stock's big move higher evidence of a much stronger long-term investment thesis?
Big tailwinds
It's not surprising that Netflix's stock has risen sharply recently. The company's financials are improving on almost every key metric. The company reported fourth-quarter results on Tuesday. Its year-over-year revenue growth rate went from 1.9% in the fourth quarter of 2022 to 12.5% in the fourth quarter of 2023. Over this same time frame, earnings per share increased from $0.12 to $2.11, paid memberships rose from 231 million to 260 million, and quarterly free cash flow soared from $332 million to nearly $1.6 billion. Not to mention Netflix's total diluted share count decreased from about 451.6 million to 444.3 million during this period thanks to a well-timed share repurchase program.
There's a lot to like about Netflix right now.
"Our healthy top line growth reflects the benefits of paid sharing, our recent price changes and the strength of our underlying business driven by a strong slate," management said in the company's fourth-quarter shareholder letter.
What's more, Netflix said last week that it anticipates even faster revenue growth and a whopping 56% year-over-year increase in earnings per share in the current quarter -- a growth rate that would put Netflix's first-quarter earnings per share at $4.49. This huge increase in earnings is expected to come from further operating margin expansion.
Looking even further out, Netflix's fast-growing but still small advertising business should start having a material impact on the company's business by next year. Though Netflix's ad business is still small, investors shouldn't underestimate its long-term potential impact on the company and the stock. Management said 40% of new membership sign-ups in markets where Netflix offers ad-supported memberships opt for this new tier. Further, this new segment's growth has been astounding, growing 70% quarter over quarter in Q4 -- and that's on top of 70% quarter-over-quarter growth in the prior period.
Valuing Netflix stock
Considering Netflix's impressive business momentum, the stock's recent surge higher seems to be justified. Sure, shares may look expensive at first glance given the stock's current price-to-earnings ratio (P/E) of 45. But strong top-line momentum and an expanding operating margin could lead the company's earnings per share to soar in 2024. This would quickly bring down the stock's P/E to a more attractive level. Analysts certainly expect robust earnings growth. That's why Netflix stock's forward price-to-earnings ratio is just 32.5.
Trading at just 32.5 times analysts' consensus forecast for Netflix's 2024 earnings per share, the stock looks like a hold today. A handful of powerful tailwinds could drive robust growth for the company for years. Further, Netflix's dominant business offers investors a powerful stream of recurring and reliable subscription-based revenue, making a strong case for the stock to trade at a high valuation multiple. Continued membership growth, more membership price increases, and a fast-growing advertising business arguably justify the stock's current valuation.
