3 Red Flags for Netflix after Earnings

10/18/2017 11:54 am EST

Focus: STRATEGIES

Chris Preston

Investment Analyst, Cabot Wealth Network

Netflix (NFLX) continued to grow its subscriber base at a breakneck speed in the third quarter. But Monday’s Q3 earnings report also revealed a few troubling trends that could drag NFLX stock down from its near-record perch, cautions Chris Preston, editor of Wall Street's Best Daily.


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First, the good news: the streaming-video giant added 5.3 million subscribers worldwide in the third quarter, blowing away Wall Street estimates of 4.5 million new subscribers. Sales were only a tick higher than analyst estimates, but improved 30% from the same quarter a year ago.

Both numbers were particularly encouraging considering the company has started raising prices for U.S. subscribers for the first time since 2015.

Now, the bad news. Here are three red flags I spotted in Monday’s report that could threaten to derail the rally in Netflix stock.

Red Flag #1: Weak Subscriber Guidance

Though Netflix’s latest price hike (to $11 a month, up from $10) didn’t slow subscriber growth in the third quarter, it looks like it could start to become a drag in the fourth quarter. The company expects to add a mere 1.25 million U.S. subs in the current quarter, well below the 1.63 million analysts were looking for.

Red Flag #2: Big Spending on Original Programming

Original programming at Netflix started as a slow drip, with award-winning shows like House of Cards and Unbreakable Kimmy Schmidt. It’s now a full-on geyser, with seemingly dozens of new original, Netflix-produced shows popping up every time I sign in.

The company doesn’t plan to turn off the tap anytime soon: it has $17 billion in future commitments to original programming over the next few years, including a $7-$8 billion investment in 2018 alone.


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With just over $2 billion of cash in its coffers, Netflix may need to raise prices even more to fund its aggressive spending on original shows and movies. And that could further slow its U.S. growth, and possibly turn off investors.

Red Flag #3: Earnings Shortfall

While subscriber growth and sales numbers outpaced analyst expectations, earnings came up short. On a GAAP basis, Netflix earned $0.29 per share in the third quarter, shy of the $0.32 Wall Street had anticipated. It’s the third straight quarter that the company’s bottom-line numbers have either missed or matched analyst estimates.

Add in the fact that NFLX stock just poked its head above 200 per share for the first time ever, and there’s reason to believe a comedown is imminent. It’s been yet another amazing year for one of the market’s great growth stocks (and a member of the so-called FANG stocks). Shares are up more than 60% in 2017, and have nearly doubled in the last 12 months.

Given those returns, it’s normal for a stock to go through a natural short-term pullback. With slowing U.S. growth and debt sure to pile up due to the accelerated spending, I’d be surprised if NFLX doesn’t hit a bit of a rough patch in the coming months.

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