Is Netflix Stock Overvalued?

Is Netflix Stock Overvalued? The list of streaming services is growing rapidly. From established platforms like Amazon Prime Video to popular newcomers like Disney Plus, just about every media and entertainment company in the world is scrambling for a share of this lucrative market.

However, despite their best efforts – and the lure of Disney princesses  – no one has managed to knock streaming pioneer Netflix from first place. 

Much of Netflix’s strength comes from its experience. Specifically, since the days of mailing single DVDs to its customers, Netflix collected data in massive quantities.

More importantly, the company prioritized analysis of that data. As a result, Netflix has a deep understanding of its customers’ interests and habits, and it moves quickly to exceed users’ expectations in terms of content selection and digital features. 

While Netflix is doing a lot of things right, the data piece may be its biggest competitive edge. Certainly, other streaming services would like to match the success of certain Netflix originals, but that’s not what’s holding them back. Among other things, Netflix uses its intimate knowledge of its subscribers – along with a proprietary algorithm – to connect them with content that will keep them watching for hours at a time. 

Netflix has had relatively steady growth in stock prices since 2014, but 2020 is a different story altogether. The year opened with shares trading around $325 each, but they were closer to $500 by the end of September. Does that price reflect the company’s true worth, or are Netflix shares due for a correction? In other words, is Netflix stock overvalued?

Netflix Was A Big Winner  During Lockdown

There are plenty of reasons why Netflix has grown in recent years, but 2020 is an entirely different story. As the novel coronavirus moved from nation to nation, governments took drastic steps to contain the outbreak.

Large swaths of the world population were locked down. Non-essential businesses closed, and people were expected to stay in their homes. Companies able to support the sudden lifestyle changes with digital entertainment saw users skyrocket. Revenues and profits followed, sending share prices up. 

Netflix, with its large content selection, extensive brand awareness, and advanced technology, was an obvious first choice for newly bored and isolated consumers.

In the first two quarters of 2020, Netflix gained 25.9 million net new subscribers. That’s equivalent to its total net new subscribers for  2019. What makes this figure all-the-more impressive is that Netflix attracted these subscribers despite the November launch of wildly popular Disney Plus.

Most analysts aren’t especially surprised that the service achieved these figures – it’s more the compressed timeframe in which the dramatic increase occurred.

Subscriber growth and the resulting revenue is directly responsible for the speed of Netflix’s increased valuation, which leaves investors wondering whether a sudden, sharp drop is on the horizon.

Netflix Financials & Growth Are Stellar

Including the 2020 boost in subscriber base, Netflix reported close to 193 million paid accounts as of June 30th. The rest of the second quarter results were just as impressive.

Revenues went up 25 percent year-over-year, totaling $6.1 billion – a record high for the company. Net income came in at $720 million, or $1.59 per share. That’s a year-over-year improvement of 165 percent. 

It is interesting to note that investors weren’t as enthusiastic about these results as the numbers would suggest, and share prices declined a bit following the announcement. This was due, in part, to the fact that management had projected second quarter earnings per share of $1.81 when reporting the first quarter results.

The difference occurred, because business leaders hadn’t accounted for one-time, non-cash charges of $339 million in their guidance. 

The company also indicated that it didn’t expect to see the same runaway subscriber growth in the third quarter, which left some investors concerned that a drop is coming.

They decided to pull out their profits right away, rather than risk watching those numbers decline. Was that move short-sighted given Netflix’s prospects, or are they right? Is Netflix valuation too high? 

Will Netflix Stock Drop?

Given the underlying cause of Netflix’s remarkable 2020 rise, investors are asking the obvious question: when the pandemic ends and consumers can return to their normal routines, will they cancel their Netflix accounts? In other words, will Netflix stock drop? The answer is probably yes, a bit – but that likely doesn’t matter long-term. 

Certainly, trading might slow and prices might come down somewhat when Netflix inevitably returns to a more sustainable pace of growth. The financials will show a year-over-year decline, and some investors will move on to the next big thing.

However, that doesn’t mean selling Netflix shares right now is a smart move, and new investors should still consider buying in. Despite an eventual drop, Netflix is well-positioned to deliver solid performance long-term, regardless of external influences. 

That’s because Netflix has something most streaming services don’t: customer loyalty. While competitors experience high rates of churn, most Netflix subscribers are in for life. That’s important for two reasons.

First, it is obviously more lucrative to retain existing customers while attracting new ones, rather than relying on new subscribers to replace cancelled accounts.

Second, that loyalty means Netflix customers will pay more for the service. 

The company has increased prices several times in recent years with little or no impact to churn rates. One researcher polled a subset of users to measure their tolerance for another rise in monthly fees.

The results show Netflix would likely see little or no negative impact by upping rates an additional $2 per month. If the company chooses to make such a move, as it likely will, that’s another $1.7 billion in revenue from the North American market. 

Is Netflix Stock Overvalued? The Bottom Line

The pandemic might have prompted Netflix’s extraordinary performance in 2020, but that doesn’t mean it is overvalued.

Certainly, there will be ups and downs as with any stock, but the consensus is that Netflix is still a buy at the current price.

Few companies have the sort of pricing flexibility that Netflix’s loyal customer base offers, which gives analysts confidence that any drop in share prices will be temporary. 

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.