Netflix Stock Drops 11% In A Month; Opportunity For Investors?

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Trefis
NFLX: Netflix logo
NFLX
Netflix

Despite a 64% rise since its March lows of this year, at the current price near $490 per share, we believe Netflix stock (NASDAQ: NFLX)  still has some upside left. Netflix stock rallied from $299 to $491 off its recent bottom, compared to the S&P 500 which increased by 60% from its recent bottom. The stock outperformed the broader market over recent months due to increased demand for streaming services on account of home confinement of people during the ongoing pandemic. NFLX stock dropped 11% in the last one month after the company missed all targets in its Q3 results. But streaming as a business is projected to register continued growth in the next few years. Despite the stock being more than 50% above its December 2020 level, expectations of continued growth in streaming demand and improving earnings is expected to drive the price higher. However, the stock is unlikely to see a sharp rise (as was seen over recent months) as the lifting of lockdowns is leading to a sharp drop in subscriber growth. Thus, the stock will see a marginal growth of 4%-5% in the near term. Our dashboard Buy Or Sell Netflix Stock has the underlying numbers.

Some of the stock price between 2017-2019 is justified by the 72% rise in Netflix revenues, from $11.7 billion in 2017 to $20.2 billion in 2019, led by strong growth in streaming demand. This effect was further amplified by net income margins almost doubling from 4.8% in 2017 to 9.3% in 2019. On a per share basis, earnings increased by a whopping 230% led by a sharp rise in revenue and margins, while shares outstanding increased only by 1.4%. Netflix saw an impressive rise in profitability as its pays for its single largest expense – content – on a fixed cost basis.

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Higher earnings were somewhat offset by a drop in the P/E multiple, which more than halved from 150x in 2017 to 75x at the end of 2019, as the stock price growth was lower than the increase in EPS as Netflix started losing US streaming subscribers in 2019. However, this trend was reversed with the multiple rising in 2020 and currently standing above 115x, mainly due to rising streaming demand on account of the coronavirus crisis as people are spending more time watching content, thus giving a boost to demand for home entertainment options.

Where is the stock headed?

The global spread of coronavirus led to lockdown in various cities across the globe which led to higher demand for streaming services. This was reflected in the first two quarter numbers of Netflix for 2020. The streaming giant added 16 million subscribers in Q1 and another 10 million in Q2, taking the total addition to 26 million in the first six months of 2020. To put things in perspective, Netflix added 28 million subscribers in all of 2019. Q2 revenue touched $6.1 billion, a quarterly high for Netflix. However, this was a one-time benefit, as the lifting of lockdowns led to a drop in subscriber growth. This was evident in the Q3 results where the company added only 2.2 million subscribers and also missed the revenue as well as the earnings target.

The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Netflix still holds the leadership position in the streaming space but is facing increasing competition from new entrants like Disney, AT&T, and Comcast. Additionally, the possibility of a hike in subscription rates next year could also lead to volatility in the stock in the next few months. Subdued growth expectations, rising competition, and lack of diversification is expected to push Netflix’s P/E multiple down close to 60x. But, continued healthy growth in margins and earnings in 2021 as well, will offset the drop in P/E, thus leading to a slight rise in stock price. Netflix valuation by Trefis works out to $510, slightly higher than the current market price.

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