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Netflix NFLX reported is fourth-quarter earnings on Jan. 21. Here is Morningstar’s take on Netflix’s results and the outlook for the stock.
What We Thought of Netflix’s Q4 Earnings
Netflix posted record quarterly and annual net member additions, with 19 million in the fourth quarter and 41 million for the full year. Growth in sales (15% year over year) and operating profit (52%) maintained their recent rapid pace. The firm also announced price increases.
Why it matters: The fourth-quarter member surge, combined with price increases in the United States, Canada, Portugal, and Argentina, extends the runway for Netflix to maintain mid-teens sales growth through 2025.
While growth will likely slow in 2025, we had expected a bigger slowdown, as we thought the firm had passed its biggest new member opportunity brought on by the crackdown on password sharing.We still think penetration opportunities in the US and Canada, and Europe, the Middle East, and Africa—the two highest-priced regions—are modest. Price increases and advertising revenue should be the bigger growth drivers, which should moderate.
The bottom line: We raised our fair value estimate to $700 per share from $550, based on higher sales projections over the next five years and slightly wider margin expansion.
We assign the firm a narrow moat and think it is leaps and bounds ahead of competitors, but with the stock trading at 40 times our 2025 earnings projection and growth decelerating, we think shares are overvalued. Our fair value estimate implies a 2025 earnings multiple of 30.
Key stats: Profitability remains impressive, but gains are slowing. Operating margin was 22% in the fourth quarter and 27% for the full year, both up about six percentage points. 2024 free cash flow was $7 billion, the same as 2023.
We expect Netflix to gain operating leverage on many of its costs, but the need for continually more content spending and marketing and production for major events will limit the magnitude.2025 guidance is for a 29% margin, $8 billion free cash flow, and about $18 billion in 2025 content spending, up from $16 billion. At that level, we think free cash flow can reach $10 billion.
Netflix Stock Price
Source: Morningstar Direct.
Fair Value Estimate for Netflix
With its 2-star rating, we believe Netflix’s stock is overvalued compared with our long-term fair value estimate of $700 per share. We project about 10% average annual revenue growth over our five-year forecast, and we believe there’s room for margin expansion, as international markets mature and benefit from greater scale.
Netflix’s biggest cost is content spending. We project nearly $18 billion in spending in 2025 and high-single-digit growth each year thereafter. Content amortization, which is the figure reflected in the income statement, should grow at a similar rate. However, we believe there will be operating leverage on other costs, resulting in operating margins rising from 27% in 2024 to almost 32% by 2028. With sales growing faster than content spending and other costs, we expect free cash flow to grow from $7 billion in 2024 to $15 billion by 2028.
Read more about Netflix’s fair value estimate.
Netflix Stock vs. Morningstar Fair Value Estimate
Source: Morningstar Direct.
Economic Moat Rating
We assign Netflix a narrow moat based on intangible assets and a network effect. Two advantages set the firm apart from its peers. First, it has no legacy assets that are losing value as society transitions to new ways of consuming entertainment at home, letting it put its full effort behind its core streaming offering.
Second, Netflix pioneered its industry, providing a big head start in accumulating subscribers and moving past the huge initial cash burn needed to build a successful streaming service. This subscriber base was critical in creating a virtuous cycle that we doubt can be breached by more than a small number of competitors.
Ultimately, having a successful streaming service is all about offering customers a continuing depth of appealing content at a price point consumers deem reasonable. The industry is not necessarily a zero-sum game, as customers can always add incremental subscriptions. But consumer budgets are finite, so practically speaking, we expect only a handful of streaming services to consistently hold large customer bases, which we think will be necessary to continue funding content investments.
Read more about Netflix’s economic moat.
Risk and Uncertainty
Our Uncertainty Rating for Netflix is High, largely based on the evolving streaming media landscape and the additional competition the company now faces. In our view, Netflix’s tremendous success is due largely to it being a first mover in the streaming industry and successfully adapting its business model while peers largely focused on their legacy businesses.
Other factors that bring greater uncertainty include the firm’s nascent ad-supported service, which will require the firm to successfully build out advertising capabilities, and the shift to creating its own content to a greater extent, as content owners have become more reticent in licensing programming to third parties.
Read more about Netflix’s risk and uncertainty.
NFLX Bulls Say
Netflix has created many hit shows exclusively available on its platform that have attracted a massive customer base. The firm’s advantage in cash generation means this virtuous cycle will likely continue.Advertising-supported subscriptions will open Netflix to a new base of subscribers and a potentially substantial new source of revenue.Netflix has significant room to grow in international markets, where it has already shown promise with local content.
NFLX Bears Say
Netflix is beginning to face competition that it has not had to deal with in the past. As consumers have more options for quality streaming services, it’s more likely that the platform could get cut out of some consumer budgets.Netflix’s US business is mature, with a high penetration of total households, meaning price increases need to be the main source of growth, and consumers may not accept higher prices.Creating attractive content is always a gamble. The allure of Netflix’s service will always be tenuous, dependent on continually producing hits.
This article was compiled by Gautami Thombare.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.