Why Netflix (NFLX) Stock Is Still a Long Term Buy - Analyst Blog

by Thomas Young

On April 21st, Netflix NFLX will announce quarterly earnings.
 
Here's how the Netflix stock has responded to the past four earnings announcements (April 2013, July 2013, October 2013, and January 2014).

 
Though the market often reacted negatively to Netflix's 2013 earnings announcements, the company's 2013 performance was actually quite good on the whole, with gross revenue climbing from $3.6 billion to $4.4 billion and net income jumping from $17 million to $112 million.
 

 
What's driving the strength in the Netflix balance sheet and overall market gain? What's the likelihood that it will continue?
 
Here are five reasons for Netflix's strength.
 
First, Netflix continues to exhibit the desire and ability to be on the cutting edge of innovation. For example, Netflix recently announced the ability to watch shows in 4K resolution (roughly four times as many pixels as a 1080p display). Although many early adopters may not be able to take advantage of the ultra-high definition content, the signal that Netflix is ahead of the game matters for customers, and happy customers make for happy equity investors.
 
Of course, development and implementation of 4K content is only one small indication of Netflix's reputation as a high-end innovative firm (even among technology firms!). Netflix CEO Reed Hastings has an entire slide deck on how to implement a continuously innovative culture in the corporate world. If there's one thing that describes Netflix's creative culture, this is it:
 
“If you want to build a ship, don't drum up people to gather wood, divide the work, and give orders. Instead, teach them to yearn for the vast and endless sea.” ~Antoine de Saint-Exupéry
 
Second, Netflix has quickly become the standard for television watching outside of traditional TV. The product is particularly popular among younger TV watchers.
 
As the pioneer in the area, Netflix continues to have the first-mover advantage over competitors such as Amazon's AMZN Instant Video, Hulu, Apple AAPL, and HBO (subsidiary of Time Warner Cable TWX). 

As another example of Netflix's leadership, Netflix became the first ever non-traditional film or TV studio to be nominated for an Academy Award, receiving a nomination for The Square, a Netflix Original production. Netflix also hosts its own awards ceremony, The Flixies.
 
Netflix is the “keeping up with Joneses” leader in online TV and entertainment in general. As long as Netflix stays at the cutting edge of product development and offerings, the Netflix status symbol won't go away anytime soon.
 
Third, Netflix is an attractive takeover target for a company like Apple or Comcast. Rumors of a takeover bid by Microsoft or Carl Icahn began in 2012, with even Mad Money's Jim Cramer getting in on the rumor mill.
 
In November 2012, in a bid to fend off a hostile takeover bid by Mr. Icahn, Netflix adopted a “shareholder-friendly” poison pill. The main provision of the plan was the stipulation that if any investor amassed more than 10% of the company's stock, every other shareholder would be able to purchase discounted shares, thereby diluting Mr. Icahn's ownership.
 
In a change of course from the Mr. Icahn-induced poison pill, the Netflix board voted to terminate the poison pill plan two years early, on December 31, 2013 instead of November 2, 2015.
 
There is not as much speculation in 2014 as there was in 2012 on a Netflix takeover, largely because Netflix's stock price has done quite well. With that said, Netflix is on many investors' and corporations' radar. Should the stock price depreciate substantially–perhaps in the $300 range – speculation of a takeover will likely ramp up.
 
Fourth, Netflix only has 44 million subscribers worldwide. The number of households in the world is somewhere around 3.2 billion, with around 120 million in the United States. Presuming 75% of the world's households are unable to take advantage of Netflix content, for reasons such as insufficient bandwidth or lack of financial resources, then there's 800 million households Netflix can realistically offer its services to. If Netflix captured 10% of that market, that's 80 million households, or around double what the company currently has.
 
This 75% not-eligible/10% market capture scenario is an ultra-conservative scenario. The bottom line is that Netflix still has a long way to go before the market for its product is saturated.
 

 
Fifth, the economy is positioned to expand at a quicker pace over the next two years than in the previous couple of years. With an accelerating economy comes a stronger consumer balance sheet.
 
Which sector is a big winner as a result of increased consumer purchase power? Consumer Discretionary. What is an important component of the Consumer Discretionary sector? TV and entertainment. If you're a cyclical investor, now is not the time to leave Netflix's sector. The familiar pattern with 2013 earnings would indicate that the market might be disappointed with the results initially, especially with the spectacularly awesome results in January 2014.
 
Because of the increased expectations set by January's quarterly earnings, investors shouldn't be surprised if the market reacts negatively on April 21. However, the 2013 experience also indicates that investors will likely see a company still on an exponential growth trend.
 
Given that Netflix is on the leading edge of innovation and content within the broader online entertainment world, if one sees online entertainment as a boom of the future (even more so than now), Netflix is a must have in your portfolio.
 
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