The S&P 500 dropped 19% in 2022. And according to history, back-to-back down years are a rarity in the world of financial markets. In fact, the last time it happened was during the dot-com bust approximately 20 years ago. This means that investors have better days to look forward to.
With inflation showing signs of cooling, and a real possibility that the Federal Reserve will slow, or even reverse, its rate hikes sometime this year, a bull market could be on the horizon. This means that growth stocks could have their time to shine once again.
With its share price already up 23% in 2023, Netflix (NASDAQ: NFLX) should be on your watchlist. Here are three must-know reasons to buy the stock.
Strong subscriber growth
For the fourth quarter of 2022, Netflix easily beat management’s guidance of 4.5 million new customers by adding 7.7 million subscribers during the three-month period. That was great news for the stock, which is up 15% since that Jan. 19 announcement. What’s more, it can ease any worries that investors had about Netflix’s growth being a thing of the past, especially after the company lost 1.2 million customers in the first six months of 2022.
The 7.7 million new members were in the same ballpark as prior-year fourth quarters. This increase was supported by successful content releases, like Wednesday, Harry & Meghan, Troll, and Glass Onion: A Knives Out Mystery. Each of these was among the top ranked all-time releases in their respective categories, whether it be series, documentaries, or films.
What’s also encouraging for investors is that management seems optimistic about Netflix’s cheaper, ad-supported tier. “We wouldn’t get into a business like this if we didn’t believe it could be bigger than at least 10% of our revenue and hopefully much more over time in that mix as we grow,” CFO Spence Neumann highlighted on the Q4 2022 earnings call.
All about cash flow
Most of the past decade for Netflix has been characterized by bears saying the company will never be able to generate positive free cash flow (FCF). You couldn’t really blame them. Netflix was spending tens of billions of dollars every year to produce and license content to drive subscriber additions, with no clear indication of when things would change for the better.
It appears as though Netflix is now turning the corner. In 2022, the business generated FCF of $1.6 billion. And management said $3 billion is the guidance for 2023, barring any major foreign-exchange swings. That’s a welcome sign for longtime Netflix bulls.
Why is this happening now? Netflix plans to spend $17 billion on content this year, which is roughly the same amount it spent in each of the prior two years. As the user base and revenue grow, but cash outlays stay the same, those gains can translate to cash generation.
It took Netflix 15 years from the point that it started offering video-on-demand streaming in 2007 to get to a point of sustainable FCF production. There’s no doubt the company was bolstered by access to low-interest rate debt throughout the 2010s that allowed it to raise its spending to pursue growth. Having limited competition for most of that period also certainly helped.
Netflix’s massive scale, one that was spurred by being the first to the streaming game, has resulted in its now favorable financial position.
A relatively attractive valuation
One final reason that investors will want to consider buying Netflix is its undemanding valuation. As of this writing, shares trade at a price-to-earnings (P/E) ratio of 36. This current valuation is substantially lower than Netflix’s trailing five- and 10-year average P/E multiples.
The credit goes not only to Netflix’s ballooning sales, which went from $3.6 billion in 2012 to $31.6 billion in 2022, but also to the company’s expanding bottom line. In 2012, net income totaled just $17 million. In the latest year, this figure was a whopping $4.5 billion. The effect of this favorable trend is an ongoing decrease in the P/E ratio over time.
According to Wall Street consensus analyst estimates, Netflix is projected to increase sales and net income at a compound annual rate of 10% and 20%, respectively, over the next five years through 2027. If the business can continue leveraging its first-mover advantage in the streaming industry by adding more subscribers worldwide, it might be able to exceed those expectations.
That’s a good reason to think hard about owning the stock.
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Neil Patel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Netflix. The Motley Fool has a disclosure policy.