With 278 million paid subscribers globally, Netflix has cemented itself as the leader in streaming. Over the years, Netflix has managed to figure out the economics of streaming, turning a capital-intensive endeavor into a profitable and efficient business. It has grown into the type of business I look for; one with a predictable revenue stream, the ability to expand margins, and the potential to deliver sustainable returns on invested capital. Its entrenched status, loyal subscriber base, and management team known for consistently executing justifies a premium valuation.
With that said, valuations must be a consideration. After its Q4 earnings report, the stock traded up to over $980 per share. After modeling the long-term prospects for the company, the risk-reward dynamic at these levels is difficult to justify, which I will explore later in this article. This isn’t a call to sell the stock, but rather a suggestion to proceed with caution since the good news seems to be fully priced in.
How We Got Here
To understand where Netflix stands today, let’s zoom out and briefly examine the company beginning in 2018. Over this period, Netflix stock price has increased by over 260%. The stock’s performance reflects the company’s impressive financial performance and operational growth.
Netflix has grown revenue from $20.1 billion in 2018 to $39 billion in 2024, a compound annual growth rate (CAGR) of ~14%. This growth has been driven by both price increases and subscriber growth. Between 2018 and today, subscriber numbers nearly doubled from 139 million to nearly 278 million which can be attributed to both US adoption and international expansion.
During this time, operating income saw dramatic growth rising from $1.6 billion in 2018 to over $10 billion in 2024. Netflix has experienced consistent margin expansion as well growing from 8% in 2018 to nearly 27% in 2024. This margin growth is the result of revenue growth as well as strategic initiatives and operating efficiencies which have driven down costs. These include management’s strategic shift to original content, leveraging technology to improve efficiencies, and cost discipline both on content spend and operationally.
The 2022 Growth Scare
While Netflix’s trajectory has been upward, there have been challenges along the way. The most notable hiccup came in 2022. Following a surge in demand spurred by the pandemic, Netflix faced a slowdown in subscriber additions as the world reopened. The company reported a deceleration in paid memberships, and fears emerged about the company’s ability to sustain momentum.
Adding to the uncertainty was a major price hike. As competition heated up in the streaming wars, investors questioned whether Netflix had the pricing power to sustain such an increase. The result? Netflix stock dropped nearly 75%.
The market reaction signaled the perception that Netflix’s leadership in streaming had ended and growth was behind them.
But Netflix weathered the storm. By the end of 2022, the company stock price began to recover. This was followed by a full turnaround in sentiment when management seemingly took control by announcing strategic initiatives including a crackdown on password sharing, the introduction of an ad-support tier, and a focus on cost discipline.
Where We Are Today
Today, these bold moves have been net positive for Netflix. Following the initiative to crackdown on password sharing, many households that previously shared accounts have transitioned into paid memberships. This has boosted Netflix’s paid subscriber numbers.
The introduction of an ad-supported tier has led the industry. This tier caters to more price-sensitive consumers broadening Netflix’s addressable market while also offering a higher margin opportunity. In the most recent quarter, ad-tier memberships grew 34% quarter-over-quarter. Management expressed confidence in the long-term monetization potential of this offering.
New Price Hikes
This quarter also saw Netflix implement another round of price hikes. The average increase across tiers and geographies is around 14%. While 2022 should act as a cautionary tale, the market’s reaction this time has been markedly different. The market has focused squarely on the company’s financial performance and subscriber growth. The muted recognition of price hikes signals confidence that subscriber churn will be low as consumers willingly absorb the increased cost of the service. This, in turn, will protect near-term margins even as the company announced an increase in expected content spend for 2025.
Live Sports
This quarter also showcased Netflix’s evolving strategic shift toward live sports. Netflix made headlines with the success of the Paul vs. Tyson fight and Christmas day NFL games. Both drew significant attention and demonstrated the potential for live sports on the platform.
Management’s comments on the earnings call emphasized a disciplined approach to sports rights. They made it clear that while they see an opportunity in live sports, they remain committed to ensuring that any investments offered appropriate return potential. By selectively entering live sports through opportunities like women’s soccer, Netflix is expanding its content portfolio while also broader efforts to enhance engagement.
A Couple Reasons for Caution From the Quarter
But even as Netflix continues to deliver impressive results, a closer look at the quarter reveals a couple things that gave me pause.
Moderating Growth
Netflix’s revenue growth is moderating. The days of +30% revenue growth are behind us. Analysts expected revenue growth for 2025 and 2026 to be closer to 13% and 12%, respectively. While these are still impressive given the size of the company, as the business matures, sustaining this level of growth will become more challenging. In the past, revenue growth was driven by price increases and subscriber growth. While these can still drive revenue growth, other levers including advertising and gaming will need to play a role.
Flat Free Cash Flow YoY
Despite meaningful net income growth, Netflix’s free cash flow remained flat year-over-year (yoy) at approximately $6.9 billion in 2024. The primary culprit? Content spending. Netflix’s investment in content, while necessary to maintain its competitive edge, weighs heavily on cash generation. For 2024, this number exceeded $17 billion, up from $13 billion in 2023. Management expects content spend of $18 billion in 2025.
Here is the thing: Netflix amortizes these costs over time, meaning they do not immediately affect operating results. In 2024, content amortization accounted for 53% of operating expenses, reflecting the impact of past investments on current profitability. As content spending increases, we can expect additional impacts on operating results. For 2025, these impacts will probably be offset by price increases. The point, however, is that the scale of this spending creates a challenge for FCF growth even as other areas of the business improve. This is something to keep an eye on.
Valuation: A Challenged Risk/Reward
For the most part, Netflix today presents a rosy picture. The company has proven its resilience after emerging from the challenges of 2022. And, over the company’s recent past as performed exceptionally. It is for all of these reasons that Netflix is the kind of company that should garner attention and a premium. But while Netflix’s achievements are undeniably impressive, there are limits to what can be priced in.
For this reason, valuation is the single greatest red flag for Netflix. In an effort to determine the market’s current expectations for the company, I modeled for a “best-case” scenario.
Below are the key assumptions from my DCF model:
- Revenue Growth: Assumes 15% annual growth, nearly doubling revenue from $39 billion in 2024 to $79 billion by Year 5. This assumption is in excess of company guidance and analyst expectations. This hinges on sustained subscriber growth, price hikes, and ad-tier monetization.
- Operating Margins: Projected to expand from 26.7% to 36% over five years. This assumption is driven by scale efficiencies, continued cost discipline, and success of the ad-supported tier. This also assumes minimal impacts from rising content amortization.
- Content Spending: Annual content spending growth moderates from 10.95% in Year 1 to 5% for the following years, eventually plateauing at around $22 billion. This contrasts with Netflix’s history of aggressive content investments and the potential necessity to compete for popular lives event rights.
- Discount Rate: Assumes a 10% discount rate. This reflects Netflix’s WACC.
- Terminal Growth Rate: A 4% perpetual growth rate reflects long-term streaming adoption and Netflix’s ability to sustain its leadership position in a competitive market.
Even with these optimistic assumptions, the model estimates a fair value of $940 per share, well below today’s price. While a sensitivity analysis could be used to adjust this figure, the point is this: Netflix will need near-perfect execution to justify today’s levels.
Here is what cannot happen to maintain momentum in the stock price:
- A hiccup in subscriber numbers due to the recent price increase or macroeconomic issues.
- Margin pressure due to increased content spend.
- The need for unexpected content spending as a result of competitive pressures.
- Poor execution for live events.
Final Thoughts
Netflix is clearly an exceptional business. I have highlighted its strength including its financial performance, adaptability and leadership position. The question here is not about quality; it is about valuation. Even the best businesses can be overvalued. Netflix’s current valuation reflects a level of optimism that leaves little room for error.
For long-term shareholders, I want to reiterate what I began with: This is not a call to sell Netflix. Netflix’s strengths justify a premium valuation. Netflix is not a name that should be sold in hopes of a better price later. That may never happen. However, it is worth remembering that great businesses don’t always make great investments at any price. I remain optimistic on Netflix’s future, but at current valuations, investors should be aware of the high expectations priced into the name.
Disclosure: I do not currently have any positions in this company.
