Are Netflix bears looking at the wrong numbers?

Netflix shares are on a fire sale due to a slowdown in subscriber growth. That's a far too simplistic view of a sophisticated business model.

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This article was originally published on All figures quoted in US dollars unless otherwise stated.

Netflix (NASDAQ: NFLX) skeptics had a field day with January's fourth-quarter report. Customer growth came in just below management's guidance and the official user-growth projections for the next quarter were downright disappointing. The stock plummeted 21% lower the next day as the bears finally found some hard data to chew on.

However, the Netflix worriers are laser-focused on the wrong data point. Let me explain.

Subscriber slowdown sparks a stock stampede

The management team said as much in the fourth-quarter earnings call. Co-CEO Reed Hastings noted that the quarter was healthy due to higher viewer engagement and lower subscriber churn. CFO Spencer Neumann pointed out that Netflix is adding customers even in this lull, just at a slower pace than usual. Overall, Netflix's leaders tried to steer the discussion in a more productive direction, but the effort was in vain.

Investors saw this discussion, shrugged, and moved on to cut Netflix's share price down to size. 

How Netflix views its financial figures

A few weeks later, Netflix had another chance to point investors at the right metrics. Speaking at last week's Morgan Stanley Technology, Media, and Telecom Conference, Neumann gave this succinct description of how Netflix evaluates its business:

I think there's probably an overly focused attention on subscriber numbers.

What we focus on is, building a great business. We're focused on growing revenue, growing profits, growing cash flow, and that's about driving not just membership, but in increasing engagement and obviously, as we increase member value, pricing occasionally into that value that we create.

So for us, it's the combination of those things as opposed to a year-to-year or quarter-to-quarter member number. And we believe, with high conviction, that we'll continue to drive double-digit revenue growth, continue to increase our profit margins as we've talked about. And not just that path to cash flow breakeven, but now growing positive free cash flow.

Netflix is a passion brand

In other words, it would be silly to focus exclusively on growing the membership counts.

To that end, Netflix would perhaps be best served by slashing prices and licensing lots of content from other producers at pennies for the dollar. That approach would pull in millions of price-sensitive customers, but those subscribers would have little reason to stay loyal to the Netflix service. Another bargain-bin streaming service could easily steal those customers away.

So Netflix makes billion-dollar investments in producing original shows and movies of prize-winning quality, and then charges a premium price for the opportunity to watch that exclusive content. As the company states in its publicly available long-term plan, Netflix wants to be a top-shelf name that people get excited about and are willing to pay more for:

"Netflix is a focused passion brand, not a do-everything brand: Starbucks, not 7-Eleven; Southwest, not United; HBO, not Dish."

There's a constant tug-of-war between subscriber growth and monetizing efforts. Right now, Netflix has a slightly tighter focus on boosting the bottom line than on optimizing subscriber counts. Throw in the uncertainty of the ongoing pandemic and geopolitical tensions, and you may get a brief period of limited subscriber growth.

But the long-term growth story remains massive. Balancing that line between growth and profit, Netflix wants to generate meaningful cash profits and pour most of the winnings back into a robust business model and content portfolio for the long haul. So staring yourself blind on a quarter or two of modest subscriber growth is a big mistake.

At a 51% discount to October's all-time highs, Netflix is a no-brainer buy today. 

This article was originally published on All figures quoted in US dollars unless otherwise stated.

Anders Bylund owns Netflix. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns and has recommended Netflix and Starbucks. The Motley Fool Australia's parent company Motley Fool Holdings Inc. Southwest Airlines and recommends the following options: short April 2022 $100 calls on Starbucks. The Motley Fool Australia has recommended Netflix and Starbucks. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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