We can debate whether investing in Netflix is a good or bad option, but there is no disputing that the American entertainment company has changed the rules of the game in the TV series and movie production industry. It is the other companies in the entertainment business that have had to adapt to Netflix’s “streaming” model, as evidenced by Disney’s acquisition of BAM Media and Fox Entertainment.
The undoubted innovation has been rewarded in Netflix’s (NFLX) share price, which, generally speaking, have a lifetime bull run behind them:
In fact, Netflix has reached an all-time high of $436 per share as of this writing, following spectacular subscriber growth in the first quarter of 2020. Although many investors are concerned about the company’s high valuation and negative cash flow, we believe Netflix’s stock price can reach $600 by 2023.
Why investing in Netflix is still a great opportunity in the middle of 2020
1. Netflix has emerged victorious from the Coronavirus crisis
In the first quarter of 2020, Netflix generated nearly $5.77 billion in revenue, a year-over-year growth of 27.6%. Its operating profit was $958 million, with an operating margin of 16.6%. Due to the global quarantine, the number of users subscribed to the platform increased to 182.86 million, an increase of 22.8% compared to the first quarter of last year. Netflix gained 15.77 million new subscriptions, 7 million above estimates.
The market responded optimistically and raised its share price to an all-time high. However, the company perceives that the unexpected growth experienced as a result of the quarantine may take it away from its normal organic growth trend of previous years. It, therefore, expects slower growth as the quarantine is gradually lifted in different countries.
Over the past five years, Netflix has managed to increase the number of global streaming subscribers by about 25% per year on average. In 2019, annual subscriber growth slowed to almost 20%.
2. A world to conquer: Netflix is expanding internationally
The main driver of Netflix’s subscriber growth was international markets. While from 2015 to 2019, the number of subscribers in the US increased by only 40% to 61.1 million, subscribers in international markets grew 4 times, from 27.4 million to 106.1 million. According to forecasts, most of Netflix’s future growth will continue to come from international markets.
Summary: The international market represents for Netflix a huge vein to exploit, a whole world to grow –and a great opportunity for all those who decide to invest in Netflix.
3. Netflix is able to increase the subscription price (Because it knows exactly what its customers want)
A very positive aspect of Netflix is its ability to raise subscription prices without losing subscribers. Among other competitors, including Amazon (AMZN) Prime Video, HBO, and Hulu, Netflix has raised subscription prices the most. In 2019, its standard HD-quality monthly plan increased 18.2% to $12.99 from $10.99. Netflix has become the second most expensive streaming service behind HBO, which charges $14.99/month.
In the coming years, we believe Netflix can further increase subscription prices if it continues to produce high-quality content, as evidenced by the 17 nominations received in the film and television categories for the 2020 Golden Globes. Of the top 20 most-watched global shows in 2019, all but one are on Netflix.
But that’s not where it ends. Netflix has been using the data it has on subscribers’ tastes not only to target content to them but also to produce new content to suit viewers’ demands.
In other words: your business model becomes much more attractive to the customer, a key reason why new subscribers come to the company and current ones don’t want to leave, even when rates increase.
Summary: Because Netflix knows exactly what content its subscribers demand and because of the high quality and success of the shows it produces, the U.S. streaming company can afford to raise subscription prices (and revenues) without negatively impacting subscriber numbers.
4. Netflix spends more than it takes in (Shouldn’t this be an argument for not investing in Netflix?)
Many investors worry about the consistently negative operating cash flow that Netflix has had in recent years. However, the primary reason why operating cash flow is negative is due to investment in content assets.
In 2019, Netflix generated about $1.87 billion in net income, but its operating cash flow was $2.89 billion. The negative operating cash flow was mainly due to a $13.9 billion investment in content assets. If Netflix had not invested in content, its operating cash flow could have risen to $11 billion. However, the company needs to invest in content assets to maintain the pricing power described above, as well as its relentless international expansion.
In fact, if we look at the U.S. streaming company’s historical data, we see that negative cash flows have never been an impediment to Netflix’s stock price continuing to climb relentlessly:
We must also consider that the content Netflix creates has the potential to monetize for years, or even decades. A strong database of content — that is, the heavy investment in content production — allows Netflix to have an asset that will yield a future profit for years.
Summary: Netflix knows perfectly well that investing in content today translates into profits and benefits for tomorrow. Moreover, the American streaming company has invested large amounts of capital to conquer international markets; an investment whose fruits it is beginning to reap.
5. Investing in Netflix is synonymous with investing in a company with 23 years of experience (and an enormous capacity to adapt)
This may come as a surprise to some, but Netflix has been publicly traded for longer than Facebook or Google, although it has taken longer to reach stardom. In fact, Netflix was founded on August 29, 1997, before the dot-com bubble.
Netflix was a very good investment between 2003 and 2009, increasing year-on-year it’s market capitalization by 33.36% and its total market capitalization by approximately $3 billion. However, it became a superstar investment between 2010 and 2017, adding about $120 billion in value over the period, which translates to an annual compound annual growth rate of more than 50% per year.
The fuel Netflix has used to boost its stock price is its subscriber base. The company seems to have found the secret to growth. To the above we have to add that, even and with all the challenges that Netflix has encountered along the way, it has managed to keep its revenues at a fast upward pace:
While Netflix has been able to grow revenue in each of the three consecutive five-year periods it has existed, 2002-2006, 2007-2012, and 2013-2017, during each period the company has faced challenges to which it has adapted and survived:
- DVD in the mail: in the first period, from 2002 to 2006, Netflix’s business model consisted of sending DVDs and videos to its subscribers, challenging the video rental business, in which video rental stores were the traditional business, and Blockbuster was the dominant player.
- The streaming boom: it was between 2007 and 2012 when Netflix took advantage of changes in technology and customer preferences. As the technology evolved to enable streaming movies over the Internet, Netflix adapted to this change, but not before weathering difficult times, while its traditional competitors failed thunderously. Moreover, at this stage, content producers (the movie studios) started charging higher prices for their content, which reduced Netflix’s margin.
- Content creation: in retrospect, the studios probably wish they had not squeezed Netflix, because the company reacted by taking more control of its own destiny in the 2013-2017 period, creating its own content, first with TV series and then with movies with direct streaming. The results have changed the entertainment business, but above all, they have allowed Netflix to achieve its consolidation.
Summary: Investing in Netflix means investing in a company with more than 2 decades of experience, with great resilience and adaptability, which has managed to overcome countless challenges, wipe out many of its competitors and emerge stronger from adversity.
Conclusion: Netflix stock could top $600 by the end of 2023
There is undoubtedly increasingly fierce competition for more subscribers among the major streaming video companies (Netflix, Disney Plus, Amazon Prime, Hulu, etc.). But even so, the global Subscription Video on Demand (SVoD) market is expected to continue to grow at an unstoppable pace over the next few years.
In other words: This is a continuously growing market in which there may be room for everyone, and everything points to the fact that Netflix can continue to dominate it with relative ease.
In short, investing in Netflix to date still represents a lucrative opportunity. By way of summary, these are the arguments that support our optimistic forecast for Netflix’s future and its share price:
- Investment in content: Netflix spends billions on the content it offers its subscribers, and the extent of its spending can be seen in its financial statements. The way Netflix accounts for its content spending complicates measurement, as it uses two different accounting standards, one for licensed content and one for productions, but capitalizes and amortizes both, albeit on different schedules, and based on viewing patterns.
- An increasing amount of that spending is going to original content production: Netflix’s decision to produce some of its own content in 2013 triggered a shift toward original “in-house” content that has accelerated since that year. In 2017, the company spent $6.3 billion on original content, placing it among the top spenders in the entertainment business.
- Netflix is adept at managing analyst expectations: one characteristic that all the FANG stocks (Facebook, Amazon, Netflix, and Google) share are that, rather than letting equity research analysts set the rules of the game, they are the ones who generate their own stories and play with analysts. Netflix, for example, has managed to make the expectations game based on subscriber numbers, and every company earnings report has these numbers at its core, paying less attention to content costs, attrition rates, and negative cash flows.
- Netflix is an experienced, resilient company in the midst of international expansion: one of the consequences of making it a numbers game is that Netflix has focused on subscribers, it has had to go global, with Asia being the gold mine of the immediate future. Moreover, over the last 2 decades, Netflix has proven that it is able to face a multitude of challenges, becoming an even stronger company.
Netflix has created a business model that burns massive amounts of money on content, uses that content to attract new subscribers, and then uses those new subscribers as its path to increase its market value. It’s clear that investors have bought into the model which, while a heavy user of money, has no escape hatch or cushion.
For better or worse, Netflix has changed not only the entertainment business but also the way we watch television and movies. In the process, it has also enriched its investors. Its value is significant and makes it one of the largest entertainment companies in the world.
For all of the above, we believe that Netflix has been, is, and will be a good investment and should be bought at a target price of $600 by early 2023.
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