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For Netflix, Inc. (NFLX) Earnings, Focus on Subscribers, Not Profits

Vince Martin

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

Over the past five years, Netflix, Inc. (NASDAQ:NFLX) stock has gained a whopping 1,210 percent. All the while, naysayers have surrounded NFLX stock. Even shorts have targeted the issue: 6% of Netflix stock still is shorted at the moment, and the figure was well over 10% in the first half of last year.

For Netflix, Inc. (NFLX) Earnings, Focus on Subscribers, Not Profits

Source: Vivian D Nguyen via Flickr (Modified)

Netflix simply has shrugged the doubters off. And the rise in Netflix stock over that period has largely been based on one factor: subscriber growth. Netflix is profitable, but barely so: consensus EPS of $1.05 for 2017 implies a whopping 150x P/E multiple for Netflix stock.

The company continues to burn cash: free cash flow was negative $1.7 billion over the past four quarters. And Netflix itself said after Q1 that it would continue to issue debt to buy and create more content — and draw more subscribers.

From the perspective of NFLX stock, that decision makes a lot of sense. Because, so far, NFLX stock owners and traders have basically ignored profit and cash flow figures. Instead, they’ve focused solely on subscribers. And that, in large part, is why Netflix stock has risen by a factor of 13 over the past five years.

Heading into the NFLX earnings report for Q2 on Monday, then, it seems likely that subscriber growth will once again be the most discussed metric in the report. And until that changes, betting against Netflix stock seems rather unwise.

Netflix and Subscriber Growth

At the end of Q1 2012, Netflix had 23.4 million subscribers in the U.S., and 3 million overseas. Five years later, the U.S. subscriber count has more than doubled. International subscribers were almost sixteen times higher, at 47.9 million.

The company’s Q2 guidance suggests further growth. Netflix projects another 850K US streaming subscribers, and 2.6 million additions in its international business. The combination would get Netflix over 100 million subscribers for the first time.

A beat on subscriber numbers certainly will move NFLX stock — because the correlation between subscribers and Netflix stock has been increasingly clear over the past few quarters. Q1 numbers disappointed on subscriber growth, and NFLX stock fell 3% despite positive commentary from management on operating margins. Q4 beat, and Q3 was a huge positive surprise — and Netflix stock gained both times (including a major jump after the Q3 report which kick-started the current rally.)

Even looking back to the first two-thirds of 2016, when Netflix stock was struggling (even dipping below $90 in July), the subscriber numbers were to blame. U.S. streaming net additions were just 16,000 total in Q2 — which led to fears that Netflix’s market was saturated and/or competition from Amazon.com, Inc. (NASDAQ:AMZN) and other streamers was eroding its business.

As such, it seems unlikely that other aspects of the Q2 earnings report will move Netflix stock much, if at all. The question beyond the Netflix earnings release is when that will change.

What Will Change the Attitude Toward NFLX Stock?

The subscription growth so far has negated many of the bear theses toward NFLX stock. Netflix bears were initially skeptical the company could penetrate international markets at all. But current trends suggest that Netflix actually will have more subscribers overseas than in the U.S. as soon as Q3 (and possibly in Q2, if the numbers surprise).

Competition from Amazon, Hulu and other streamers was supposed to threaten Netflix’s market share. But as it turns out, “cord-cutters” largely have added those services to Netflix, rather than replacing it. Meanwhile, Netflix has a trick up its sleeve if subscriber growth slows: it can cut down on password sharing.

As long as those subscribers keep growing, Netflix stock seems likely to do the same. Investors seem content to believe that Netflix can figure out profitability eventually, and that the billions spent now on original content will pay dividends (if not literally) in the future.

That will change — 7% operating margins aren’t hugely attractive, given the risk taken in content development. Netflix won’t be able to raise debt forever. At some point, the story surrounding Netflix stock will change toward its profitability.

But that will only happen when subscriber growth slows. And while one survey raised concern about the Q2 number, from a long-term standpoint, Netflix has plenty of room to expand, particularly overseas.

As long as Netflix and its FANG peers Facebook Inc (NASDAQ:FB), Amazon, and Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) are rising, subscriber growth will be enough. And that seems likely to keep NFLX stock afloat through the Q2 earnings — and beyond.

As of this writing, Vince Martin has no positions in any securities mentioned.

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