Netflix (NFLX -0.63%) has seen its stock drop around 46% since peaking last summer, as earnings growth has slowed and management has moved to disclose less information about viewer engagement. But in my opinion, the sell-off has gone too far, and investors are ignoring the massive free cash flow generating capabilities of the premier streaming business.
Netflix is on track to produce $12.5 billion in free cash flow this year, and that number could climb significantly higher in the years to come. That makes the stock a compelling buy at its current price.
Image source: Netflix.
From growth engine to free cash flow machine
Netflix spent years pouring cash into acquiring and developing content for its streaming service. It's built a huge library of original content over its decade-plus of producing it, and it now spends about $19 billion per year on content.
That content budget isn't necessarily the largest among media companies, but management is extremely effective with its content production and acquisition decisions. With a global subscriber base, Netflix can offer a broad range of content to everyone. And when it sees traction with certain content, it's quick to double down and promote it worldwide. It sports a growing content budget for live events, which don't account for significant watch time, but drive sign-ups. As a result, cash content spend per user is relatively stable.
Meanwhile, Netflix is still signing up more users. It now has 325 million global subscribers. What's more, it's increasing its revenue per membership through a combination of price hikes and advertising. Advertising still has a lot of room to grow, bringing in approximately $3 billion this year, up from $1.5 billion in 2025. That number should continue to climb as Netflix increases engagement among its lower-tier subscribers and continues to add new live events.
NASDAQ: NFLX
Key Data Points
That should produce steady leverage in the business. Management likes to target a set operating margin at the start of every year, using revenue projections to set its content budget. The strategy consistently delivers operating margin expansion, which in turn drives strong free cash flow growth.
Management has recently used its excess free cash flow to buy back shares, which looks particularly appealing at the current price. It repurchased $11.5 billion in shares through the first half of the year and has authorization to buy back an additional $27 billion. A strategic acquisition could help bolster its revenue growth and provide additional leverage long term, but buying back shares at an attractive price is also value accretive for shareholders.
With the stock trading at just 28 times free cash flow and the potential for free cash flow to grow considerably over the next few years as monetization continues to improve, investors are getting a great price on a wonderful business. Netflix stock is priced comparably to other media companies, without the drag of legacy linear networks on operations and free cash flow growth.
