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Netflix Investors Have No Reason to Panic

Daniel B. Kline, The Motley Fool

Netflix (NASDAQ: NFLX) missed its subscriber growth forecast by 2.3 million, adding 2.7 million paying customers in the second quarter instead of the 5 million it predicted. It also lost a handful of subscribers in the United States. This has caused the company's stock to drop as the media wonders if the looming loss of Friends and The Office, along with a recent price increase, has caused customers to reconsider whether the streaming leader is worth the price.

In reality, the missed forecast was a blip in accounting. Netflix added 9.6 million new customers in the first quarter and now expects to add 7 million in Q3. The company has essentially blamed the Q2 miss on making a bad prediction based on timing, underestimating just how strong Q1 was, and the lesser appeal of the original content launched in Q2.

The Netflix home screen.

Stranger Things should drive Q3 subscriptions. Image source: Netflix.

What is Netflix saying?

It's important to note that this has happened before. Netflix has missed its subscriber forecast three times (including this one) over the previous three years and come back to beat its next quarterly forecast in the following quarter. The company shared some color as to what happened in Q2 in CEO Reed Hastings' letter to shareholders.

"Our missed forecast was across all regions, but slightly more so in regions with price increases," he wrote. "We don't believe competition was a factor since there wasn't a material change in the competitive landscape during Q2, and competitive intensity and our penetration is varied across regions (while our over-forecast was in every region)."

Basically, Hastings believes that there was a little bit of a pullback in the U.S. due to the price increase. He also felt that the company's lineup of original content was lacking in shows that drive membership. He made it clear that he sees this as a matter of timing and not an underlying problem.

"We think Q2's content slate drove less growth in paid net adds than we anticipated," he wrote. "Additionally, Q1 was so large for us (9.6m net adds), there may have been more pull-forward effect than we realized. In prior quarters with over-forecasts, we've found that the underlying long-term growth was not affected and staying focused on the fundamentals of our business served us well."

What's next for Netflix?

There may come a point at which rising competition -- specifically Walt Disney's Disney+ -- places pressure on Netflix. But that day has not come yet, and Hastings expects a major bounce-back in Q3.

"Q3 has started with ​Stranger Things​ season 3, and the first two weeks of Q3 are strong," he wrote. "In addition to the recently released season 3 of ​Stranger Things​, our second half content slate includes new seasons of La Casa de Papel​ (​Money Heist​), ​The Crown​, and the final season of the iconic ​Orange is the New Black​ as well as big films like ​The Irishman​ from Martin Scorsese and action movie ​6 Underground​" (directed by Michael Bay and starring Ryan Reynolds).

The streaming giant's CEO expects that his company will add 7 million subscribers in Q3 (800,000 in the U.S.). That's more than the 6.1 million it added during the same period last year.

Q2 was an off quarter. There's no reason to doubt past patterns or Hastings' forecast for Q3. Netflix has a business that's somewhat dependent upon new content to drive subscription spikes. The return of some of its most popular shows should help the company get back on track and prove that investors should look at the long-term story, not the quarter-by-quarter numbers.

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Daniel B. Kline has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix and Walt Disney. The Motley Fool has the following options: long January 2021 $60 calls on Walt Disney and short October 2019 $125 calls on Walt Disney. The Motley Fool has a disclosure policy.