Netflix enters bear market ahead of earnings - Stock Market News

The world’s dominant streaming platform will release its latest earnings on Thursday, January 20, after Wall Street’s closing bell. Profits are expected to have taken a hit thanks to heavy spending on new content, although the most important metric will be subscriber growth. Netflix shares have suffered a serious drawdown lately and could get even cheaper in an environment where rising interest rates torment stocks with expensive valuations. 

Investing in content

Netflix enjoyed a massive boom during the early stages of the pandemic as people were locked at home. Earnings and revenue went through the roof, allowing the company to improve its margins. Of course, that catapulted the share price much higher. 

But when you pull demand forward like that, there’s usually payback down the road. That’s where we are now. The pace of increase in new subscribers fell dramatically last year as social restrictions were relaxed, which translated into a slowdown in revenue growth. 

At the same time, operating costs have started to swell thanks to some massive investments in new content. Even though this will hold back profitability for now, it will hopefully pay dividends in the long run by attracting new customers. 

All eyes on subscribers

For the final quarter of 2021, earnings per share are expected at $0.82, which would represent a 31% decline from the same quarter last year. Revenue is seen at $7.7 billion, a 16% increase over the same period. While that sounds good, it would be the slowest revenue increase in years. 

Yet what investors pay the most attention to is subscriber growth. That’s expected at 8.5 million, the same as last year but double the previous quarter. Omicron restrictions across the world seem to have helped, along with the blockbuster content that Netflix has released lately, such as Squid Game and Don’t Look Up.   

Any surprises in subscribers relative to Wall Street expectations will likely decide the initial reaction in the stock market. It is worth noting the company has beaten subscriber estimates in 6 of the last 8 quarters. 

Taking a technical look at Netflix shares, the 526 zone could provide immediate support to any further declines. On the upside, the first target for the bulls might be the 568 region, which overlaps with the 200-day moving average.  

Valuation is pricey

The main risk around the stock is valuation. The forward price-to-earnings ratio represents the dollar amount someone would need to invest to receive back one dollar in annual earnings, so the higher it is, the more ‘expensive’ a stock is considered. 

For Netflix that number stands at 41.2x, miles above the technology sector or the stock market as a whole. To be fair, this metric is inflated by the heavy spending on new content. Profits would be much stronger today if they weren’t investing. Still, the price-to-sales ratio that strips out this effect is equally unattractive at 7x. 

This means the market is pricing in a lot of future growth for Netflix. That’s a sign of confidence, but it can be a double-edged sword. When interest rates rise, the stocks that usually get hit the hardest are those with stretched valuations. 

The logic is that investors don’t need to take wild chances on speculative high-growth plays to earn a return if interest rates are moving higher. Obviously Netflix isn’t so speculative, but it is still quite vulnerable to higher rates given its valuation. 

The big picture

All told, the longer-term outlook remains favorable. Netflix is a well-run company with lots of growth ahead and a strong moat. Competition has intensified lately with Disney and others entering the streaming arena, but Netflix remains king in content and will likely maintain this lead given its heavy investment. 

In the near term, however, it faces some challenges. Revenue is slowing at a time when costs are rising, and with the Fed likely to raise rates several times this year, there could be a compression in valuation multiples that keeps the stock under pressure. We’ve already seen signs of that in recent weeks.

Ultimately, this means patient investors may be able to buy a quality business for an even deeper discount moving forward. 

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