Netflix (NFLX 2.05%) stock was flying high last summer on strong subscriber and operating income growth. But then some cracks started to appear in the business.
- Earnings growth was bolstered by unsustainable positive impacts from foreign exchange rates and price hikes.
- A Brazilian tax created a one-time earnings hit and raised questions about whether it would remain an ongoing expense.
- It tried to acquire Warner Bros. Discovery at an exorbitantly high price.
- Management's 2026 outlook showed decelerating revenue growth.
The company escaped the overpriced Warner Bros. Discovery acquisition while receiving a termination fee and pushed through another price hike sooner than expected. Investors rewarded the stock following the news, but it has since sold off to a price unseen since before 2025. The stock now sits about 42% off its high from last summer, making it an excellent buying opportunity for investors.
Image source: Netflix.
This cash machine is selling for cheap
After years of burning cash to develop original content, Netflix has transformed into a massive free-cash-flow-generating machine. The company generated about $2.3 billion in organic free cash flow in addition to $2.8 billion in cash from the Warner Bros. termination fee last quarter. Management expects $12.5 billion in free cash flow for the full year, including the termination fee.
That free cash flow growth is supported by a systematic approach to growing the business. The company's recurring subscription revenue makes projecting revenue growth relatively straightforward. It then uses that to set targets for content spend and operating margin. It aims to achieve an annual expansion of that operating margin.
Cash outlays for new content are roughly 1.1-times amortized content expenses, as the company continues to expand its content catalog to drive subscriber growth. That creates predictable free cash flow growth year after year.
NASDAQ: NFLX
Key Data Points
Importantly, Netflix's competitors are hard-pressed to match its breadth and depth of content. It has 325 million global subscribers, across which to monetize all of its content. The shift to ad-supported streaming has opened new content opportunities for Netflix, including sports and other live events. As a result, Netflix can try many different series, films, and events, and quickly double down on whatever's working. That's why Netflix is set to maintain its position as the premier streaming entertainment source for hundreds of millions of consumers, giving it pricing power.
After the crash in Netflix's stock price over the past year, investors can now pick up the stock for just 28 times free cash flow and 21 times forward earnings estimates. While the company may see its top-line growth slow, prudent content cost management will ensure it can continue growing its bottom line and free cash flow at a very appealing rate relative to the current price investors pay. It looks like a great opportunity to buy a wonderful business at a good price.
