Netflix stock rose 15% after hours as the company announced significant growth in its earnings report last night. After a disappointing few months for the streaming business, is it time to buy Netflix shares?
Strong earnings
It beat expectations on both revenue and profits last night. Reported revenue was $7.93bn (against a $7.837bn forecast) and earnings per share were $3.10 (against a $2.13 forecast).
Most importantly though, the company managed to add 2.41m new subscribers over the last three months. Management had been forecasting a 1m subscriber increase.
That’s why the stock is surging in extended trading. Last night’s results marked a sharp change of fortune for the business.
Since the start of the year, the number of Netflix subscribers had declined by around 1.2m. As a result, the stock had fallen by around 60%.
Management also announced that it expects subscriber growth to continue. In its earnings release, it indicated that it’s aiming to add 4.5m new subscribers before the end of the year.
In addition, Netflix’s new ad-supported service launches in November. Starting next year, the company will also begin making moves to crack down on account sharing.
To my mind, this is clearly an encouraging report for shareholders. But with the share price still nowhere near where it was at the start of the year, should I buy Netflix stock?
Time to buy?
I don’t own Netflix shares. And despite a positive quarter, I don’t anticipate buying the stock any time soon.
In my view, Netflix doesn’t generate enough cash to justify an investment at today’s prices. Yesterday’s report did nothing to change my mind on this.
Despite reporting $1.4bn in net income, free cash flow came in at just $500m. For a company with a valuation of $107bn, I don’t think that’s high enough.
The reason cash flow is so low is that Netflix has to spend heavily on its content. According to its financial statements, the company spent $4.5bn on content assets during the last three months.
Furthermore, this shows no signs of slowing down. The company’s spend in Q3 last year was around $4.6bn.
Since the start of the year, it has generated $4.4bn in net income, but just $1.2bn in free cash flow. It has spent almost $13bn on content.
In order to invest in the shares, I’d need to see how the company is going to produce enough cash to justify my initial outlay. The company’s content expenses mean I don’t see that right now.
Investing in Netflix
There are a couple of ways that Netflix shares could become an investable proposition for me. One is by generating significantly more revenue and profit.
If the company can generate enough income to offset its high content expenses, then I’d be willing to buy the stock. But that seems to be some way off at the moment.
The other is by bringing down its content spend and converting more of its net income into free cash. This also seems to be some way off at the moment, which is why I’m not buying the shares yet.
