Has Netflix Stock Finally Peaked?
Amid escalating trade war tensions between the United States and China, red-hot streaming giant Netflix, Inc. (NASDAQ:NFLX) stock suffered its worst drop in two years on Monday, June 25. Netflix stock closed down 6% and, at one point, was down 10%.
The weirdest thing about the big drop in Netflix stock? Netflix has essentially zero exposure to the rising trade war tensions. Netflix has zero business in China and, from where I sit, is largely impervious to anything that has happened on the trade war front thus far.
So, why did Netflix stock collapse on Monday?
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Many reasons. There was some profit-taking in the mix. Investors started to question valuation in a not-perfect operating environment. The stock had come too far, too fast.
Will the drop last? Has Netflix stock peaked?
I don’t think so. A riskier and less robust macro-economic operating environment will cause investors to re-asses what they are willing to pay for Netflix stock here and now. That should cause some choppiness in shares, and the 100% year-to-date gain likely won’t repeat itself over the next 6 months.
But, bigger picture, Netflix stock will head materially higher over the next 5-10 years.
Here’s a deeper look as to why.
Netflix Will Hit Some Road Bumps Here
Netflix stock has risen more than 100% year-to-date, more than 150% over the past year, roughly 320% over the past 3 years, and over 1,200% over the past 5 years.
At some point, this rally has to pause. Indeed, over the past 5 years, Netflix stock has gone through some rough patches. Notably, Netflix stock was stuck below $100 for most of 2016, as investors questioned the company’s the original content growth strategy.
That weakness lasted until the company reported a robust double-beat-and-raise earnings report in October 2016. That report underscored strength in the company’s original content portfolio, highlighted by Stranger Things, and provided ammunition to the thesis that good original content would drive huge subscriber growth.
Netflix stock hasn’t looked back since. The company has continued to produce quality original content. Subscribers have continued to flock to the platform. And Netflix stock has broken above $100, $200, $300, and $400.
But I think we could be coming up on one those sideways stretches again.
First off, valuation is just nonsensical here and now. I’m bullish on the company’s long-term growth prospects as being a go-to entertainment option in a majority of internet households around the world. I also think that the company has a ton of firepower through price hikes. But even under those assumptions, a $400 price tag is still a stretch.
Secondly, as a user, I’ve been unimpressed with the new original content lately. That is big because, as I’ve pointed out before, as goes Netflix’s original content, so goes Netflix subscriber growth and Netflix stock.
Ever sine Stranger Things launched in summer 2016, there has been no shortage of fresh, exciting original content on Netflix. Until now. Maybe it’s just me, but the new originals have fallen flat compared to the Netflix originals of the past 2 years.
Third, the macro-economic operating environment is getting riskier and less robust. Naturally, even though Netflix doesn’t have a presence in China, this will weigh on Netflix’s valuation. The stock is priced for perfection. But the road ahead has a lot of bumps, both macro (tariffs) and micro (competition from Walt Disney Co (NYSE:DIS)). Those bumps will inevitably hurt Netflix stock in the near- to medium-term, because it is priced for perfection.
Long-Term Outlook Remains Healthy
Overall, I think Netflix stock will go through some choppy trade for a while. The stock is priced for perfection. Perfection won’t happen. Netflix stock won’t be the biggest winner here and now.
But longer term, NFLX is a big winner.
Netflix continues to march towards global domination of the at-home entertainment space. The Netflix value proposition is excellent, convenience is second to none and competition is lacking. Granted, competition will ramp over the next several years, thanks to streaming efforts from Disney and others. But considering those platforms will also be cheap, I think the most likely outcome is that consumers have both a Netflix and Disney streaming account. The combined cost would still be far less than cable.
From this perspective, Netflix has a lot of growth left. There are around 1.7 billion TV households in the world. Netflix only has 125 million streaming members.
Over the next 5-10 years, it isn’t unlikely, considering the huge addressable market, that Netflix grows its subscriber base to 500 million. Also during that stretch, price hikes should drive average unit revenue per month to $15. That combination would imply revenues of $90 billion in 5-10 years. Assuming operating margins of 30%, you are looking at operating profits of $27 billion and earnings per share of around $40.
A basic growth multiple of 25 on $40 implies a 5- to 10-year price target of $1,000.
Bottom Line on Netflix Stock
Have we reached peak Netflix? No.
Will Netflix continue to rise by 100% every six months? Also, no.
The near- to medium-term operating environment has grown less perfect thanks to trade war tensions and rising competitive threats. But the long-term, big-picture growth narrative remains robust, and Netflix stock should shake off near-term rust and head higher in a multi-year window.
As of this writing, Luke Lango was long DIS.
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