Netflix (NFLX 1.56%) reported higher-than-expected first-quarter profits and new subscriber counts last week, yet its stock dropped 10% in response to a lower-than-expected forecast.
In this segment from the Market Foolery podcast, Chris Hill, Jim Mueller, and Charly Travers explain the reason for Netflix's low guidance. Then they talk about how this dip could be a buying opportunity for investors, given the long-term growth strategy Netflix is pursuing and the success they've had executing long-term plans in the past.
A transcript follows the video.
This podcast was recorded on April 19, 2016.
Chris Hill: Let's start with Netflix. First-quarter profits came in higher than expected. They added 2.2 million subscribers; that's more --
Jim Mueller: In the U.S.
Hill: Yes. They were expecting 1.8 million -- I mean, on balance, this looks really good. And yet the forecast they gave was a little bit weaker than some on Wall Street were expecting, and that as much as anything appears to be sending the stock down 10%.
Mueller: Yeah. Well, Wall Street is so much focused on forecasts and what the next quarter will do. I think this is actually a really good opportunity if you're interested in investing in Netflix. If you either have a smaller position than you might want, or no position at all, because down in the $90s, and heck, if we're lucky, down in the $80s, would be a great place to buy shares. And my broker's headline feed this morning, and every analyst, was just reiterating, target price $120, target price $130. I mean, that's where these guys are headed, so if you can buy it in the $90s, you're going to do pretty well.
Hill: We were talking about this earlier, Jim. Maybe I shouldn't be confused, after doing this podcast for five years. I should no longer be surprised by short-term thinking on Wall Street. But part of the bear case, if you will, had to do with their international growth not really being -- and yet, was it just three months ago, we were sitting here talking about how they'd hit all of these international markets that they initially weren't projecting to hit for at least another year or two.
Mueller: At least. Every market they've gone into, they've done better than expected. Canada, their first international launch, they reached break even a year ahead of schedule. And they're saying, "Oh, we have something going here." And then, Latin America, where they got 20 or 30 countries all at once, I'm of the opinion that fell in their lap, because they had been planning to go elsewhere at that time. And that started out a little rocky, they had some payment issues. That might be part of what's affecting the latest 130-country launch. The payments are in U.S. dollars and limited to only if you have a credit card that can handle U.S. dollar transactions.
So that might be slowing things down, and some of the headwinds. But they're going to work through it. Latin America is a great growth story now for them. All of these new markets are going to be a great growth story four to six years down the road. And as long-term investors, that's where we should be looking. That's where Reed and David Wells and Ted Sarandos, all the chief guys there, are looking. They're looking several years down the road. They're not interested in the next quarter. They're saying, "This is a 10-year game, folks, and we're playing for that."
Hill: Charly, when you look at what's playing out today in terms of the sell-off, what goes through your mind?
Charly Travers: I'm very impressed by not just the quality of the original content they've been able to make, but the pace at which it's coming out. Remember just a few years ago, they weren't doing anything. And there was a lot of skepticism about whether or not Netflix could actually come in and make high-quality TV shows and movies, and I think that's been answered with a resounding yes. I think it goes way beyond the high-profile prestige programming like House of Cards.
You go down the list into the Aziz Ansari's Master of None, Unbreakable Kimmy Schmidt, all the kids' programming, the stand-up comedy. They've got something for everybody in the family, and it's coming out every week. And I think, to Jim's point about thinking long-term with the company, that's what people should be focusing on -- they've been able to make a lot of their viewing consumers happy with all this content they're making. And their library is just remarkable, in my opinion.
Mueller: People who are thinking bearish on the company might raise the point, "Well, all that great content is costing them a lot of money." And for the original content, it does, it's all paid up front because the actors and directors and set people want to be paid. So, yeah, there's a big cash spend up front. That's why their free cash flow is so bad right now. But, there was a telling comment by, I can't remember which of the executives said it, that said, "Yeah, the costs are going up, but our revenue is going up even faster."
And that's being shown in the U.S. If you look at the improvement on their contribution margins over the years, that's the cost versus the revenue, and the revenue is growing faster than their costs. And that's what's happening. And that will begin to kick in internationally as the company continues over the next several years.
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