Online streaming network Netflix (NFLX) is leading the way in terms of innovation in a highly competitive sector. Indeed, in the streaming space, Netflix remains firmly atop most investors’ rankings right now.
The growth potential of this stock is easy to understand. With recent winners including Squid Game, Netflix has seen a surge of interest unlike during many other periods of time.
This increased interest has translated into fresh all-time highs. Last week, NFLX stock hit a daily high of $654. These sorts of levels imply investors remain bullish on the company’s long-term growth prospects.
As a first-mover in the streaming space, Netflix has created a brand-related moat that other companies have looked to encroach upon, with little success. It turns out Netflix’s offering has been stickier than many expected. Even while new entrants come in and gobble up more consumer dollars, it appears the streaming wars haven’t ended in bloodshed quite yet. Consumers see fit to have more than one streaming service, boosting Netflix’s growth prospects as it seeks new international markets for growth.
This unique business strategy has helped the streaming platform, as of June 2021, grow its customer base to 209 million paid subscribers. As mentioned, Netflix’s international focus has also included ramped-up production in countries such as Germany, Spain, Mexico, and India.
Currently, I’m neutral on NFLX stock, given valuation concerns. However, there’s a lot to like about this company’s business model. Let’s dive into why so many investors are bullish on Netflix right now.
(See Netflix stock charts on TipRanks)
A Super Gorgeous Business Model
Netflix derives a vast majority of its revenue from paid subscriptions. Accordingly, the ability for Netflix to increase its global subscriber count is of utmost importance to investors. As a high-growth stock, investors look to top-line growth rates more than bottom-line growth, at least for now.
Unsurprisingly, content is king in the streaming space. In this regard, Netflix has continued to invest billions into producing binge-worthy shows. The company’s business model has been successful thus far, with subscribers across 190 countries.
However, it is not just the subscriber numbers that drive revenue growth for Netflix. A significant TV series or movie can produce return customers. Hence, the costs to produce such content are not recurring expenses. Rather, they are long-term investments.
Investors may rightly look at the investments Netflix has made positively, in this light. Even more positively, the expectation is that this investment rate, as a percentage of revenue, will drop over time. Accordingly, as Netflix spends less on investments, it can expand its profitability. This is what’s expected to drive huge growth bursts to the company’s earnings and earnings per share. In fact, operating margin for Q3 was 23.5%, representing year-over-year growth of three percentage points.
Finally, as more and more customers stay longer on the platform, the company’s average revenue per user (ARPU) should keep increasing. All these factors have increased the operating margin for the company in the last 5 years. Further, the company expects to see continuing gains in EPS.
Scale is the Key to Profitability
Scale can drive profitability and power on the business’ content. Indeed, a streaming service with hundreds of millions of users making their utility-like payment each and every month provides cash flow stability few companies have. In line with that thinking, Netflix is often viewed as a utility-like business in terms of its cash flow generation over time.
Thus, the amount of operating leverage available to Netflix is huge. As the company ramps up its subscriber count, profits should increase over time disproportionately. At least, that’s what existing investors hope to see.
The question remains as to how aggressively Netflix will have to continue to spend to produce more content. Given rising competition in this space, that’s a more difficult question to answer. However, the good thing about original content unique to Netflix that remains on the platform in perpetuity, is that it carries a higher lifetime value than rights agreements with outside providers. Therefore, investors in Netflix appear to be bullish on this company’s prospects over the long-term.
As the company scales, expectations are that earnings momentum should pick up. The company is building a race car from the ground up right now. While expensive up-front, should Netflix continue to win the race, this could turn out well for investors.
Risks Abound for Netflix
Netflix stock is one that’s certainly valued extremely aggressively right now. Indeed, investors have reason to do so. This is a fast-growing company showing no signs of slowing. Accordingly, there’s reason to be bullish on the company’s long-term prospects.
However, Netflix will eventually need to churn out profits commensurate with its valuation. At some point, investors will want to see the cash flow in, and benefit shareholders directly.
One of the company’s most prominent criticisms is its lack of diversification from cash flows. Rivals such as Disney (DIS), for example, do an excellent job of monetizing their intellectual property. While Netflix is making headway in this regard, with new apparel offerings and the entrance into gaming and other sectors, investors will want to see results.
For these reasons and more, there’s some level of execution risk with this stock. While Netflix has thus far executed to near-perfection, any hiccup could result in a significant road bump on the company’s track higher.
For now, though, these concerns appear to be on the back burner for most investors. Indeed, Netflix stock has continued to outperform, and momentum investors appear to be content with holding this stock right now.
Analysts on NFLX Stock
As per TipRanks’ analyst rating consensus, NLFX is a Moderate Buy. Out of 32 analyst ratings, there are 24 Buy recommendations, 5 Hold recommendations, and 3 Sell recommendations.
This stock has an average Netflix price target of $679.13, implying minimal upside. Analyst price targets range from a high of $800 per share to a low of $342 per share.
Bottom Line
With the added importance of the scale and power of Netflix, this is clearly a leader that the competition is chasing. Indeed, competitive pressures exist, and this stock isn’t without risk. However, the bull argument with NFLX stock remains strong right now.
The question investors need to answer is whether they’re comfortable with the valuation. If so, this could be a great long-term growth holding in a portfolio. For those more conservative value-oriented investors, perhaps waiting for a dip makes more sense right now. After all, this is a stock that’s run very far, very fast.
Disclosure: At the time of publication, Chris MacDonald did not have a position in any of the securities mentioned in this article.
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