Netflix (NASDAQ:NFLX) stock has been soaring -- up 128% this year and 19% in the last 30 days alone. With a market capitalization of $43 billion and a price-to-sales ratio of 8.1 (about double Walt Disney's P/S ratio), investors are clearly excited about Netflix' potential. What's behind all the hype?
Here are two reasons investors are driving up Netflix' share price.
Rapid growth in user base
Central to the market optimism for Netflix stock recently has been the company's ability to rapidly grow its user base. This is especially true in the company's most recent quarter. During Q2, Netflix added 3.3 million subscribers -- 900,000 in the U.S. and 2.4 million internationally. Not only is this a record number of second-quarter additions, but the figure was also well ahead of the company's own forecast for 2.5 million net additions. Further, consider that Netflix total members in Q2 were up 31% from the year-ago quarter. This growth clearly demonstrates Netflix' growing popularity with consumers.
And the user growth story doesn't look poised to slow down any time soon. Going forward, Netflix is forecasting more record quarterly growth. In Q3, Netflix expects to add 3.55 million net members.
Supporting the case for continued growth in users, Netflix' key catalyst for attracting new members, original content, is only getting stronger.
"We believe the higher than anticipated level of acquisition was fueled by the growing strength of our original programming slate," Netflix management explained in its most recent quarterly letter to shareholders. Original content launched in Q2 alone included the first seasons of Marvel's Daredevil, Sense8, Dragons: Race to the Edge, and Grace and Frankie, as well as the third season of Orange is the New Black.
Netflix' credits a broader trend toward Internet-based television as a catalyst for user growth, too. In its second-quarter letter to shareholders management said Netflix is "at the forefront of a wave of global Internet TV adoption." It plans to take advantage of this macro trend by making its service "available throughout the world by the end of 2016."
Netflix' business model is scalable
As Netflix' business continues to grow its business is proving to be scalable.
While its total contribution margin, which the company defines as revenues less cost of revenues and marketing expenses as a percentage of total revenue, has remained about flat during the past five quarters, this is only because it's investing heavily in growth initiatives in its international markets. A closer look at the company's contribution margin for its more established U.S. market previews the scalability of Netflix' business model. Its U.S. contribution margin has been trending steadily upward in the past five quarters, growing from 27.1% in the year-ago quarter to 33.1% in Q2.
Going forward, Netflix management is confident it will continue to benefit from scale.
We continue to target a 40% US contribution margin by 2020, even though we are running ahead of plan given stronger than expected top line performance and lower content and other streaming costs.
With good reason to believe Netflix users will continue to grow and its business is headed toward improved profitability, investors have more reason than ever to believe the streaming service will continue to dominate Internet-based television. But investors should also keep in mind that its soaring share price is already pricing in an optimistic outlook. While management is giving investors plenty of reasons not to sell the stock, it is more difficult to justify buying Netflix at these prices.