3 reasons to buy Netflix, and 1 reason to sell

No investment decision is without pros and cons.

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

There are rarely any investments without risk. Typically, even in your most admired stocks, you have one or more cautionary signals. Netflix Inc (NASDAQ: NFLX) is no different.

The last few years have been volatile for the company and its stock price. It thrived at the pandemic onset when demand for at-home entertainment surged. The reversal of that trend has become a headwind. 

There are several reasons investors should buy Netflix stock right now, and at least one reason you should sell. Let's look at each in more depth below. 

1. Netflix is the leader

Netflix is the undisputed streaming industry leader. The company pioneered this form of delivering content more than a decade ago. Before then, consumers were relegated to subscribing to expensive cable TV. In addition to higher costs, cable TV offers lower value. You can only use a cable service at home or the office. When Netflix came along with a streaming service, folks could watch content on their phones, tablets, and laptops anywhere they get internet access. 

It's no surprise that Netflix has soared to reach 222 million subscribers as of December 31. The trend is unlikely to reverse, and over the next several years, Netflix believes it can reach over 500 million subscribers.

Underlying that growth is the superior customer-value proposition -- content all month for less than $20. The icing on the cake: The more people who join, the better the service becomes for everyone. The more revenue comes in, the more Netflix can allocate to its content budget. It spent $17.7 billion on content in 2021, up from $11.7 billion in the year before.

2. A profitable business model 

Streaming content lends itself to excellent efficiencies in scale. For instance, it does not cost Netflix that much more to show its content to an incremental 50 million viewers. Again, that's in stark contrast to cable TV, where each new customer needs a professional installation and expensive equipment.

The advantage is demonstrated in Netflix's growth in operating income from 2012 to 2021, when it expanded from $50 million to $6.2 billion. That's exponential growth, and it could continue as Netflix works its way toward its target of 500 million subscribers.

3. The stock is selling at its lowest price in years 

Netflix is trading at a price-to-earnings ratio of 33. According to that metric, that's the lowest it has been in nearly a decade. If you prefer the price-to-sales ratio at 5.7, that's near the lows of the last five years. Netflix stock is down 46% off its highs of late 2021. The market is concerned that subscriber growth will slow in the near term, which leads nicely into the one reason to sell Netflix stock.

A reason to sell Netflix 

Subscriber growth could be slowing or potentially even reversing for Netflix. The company experienced a surge of new signups during the pandemic, and they may begin canceling as more entertainment options become available.

During the pandemic for Netflix, one of the negatives was a slew of new entries into the streaming industry. Whereas Netflix has had mostly an open runway for the last decade, it is now facing serious competition from studios with deep resources. 

To make matters worse, the new entrants are willing to absorb operating losses in their streaming services to attract subscribers. Nearly all new entrants have priced their services below Netflix. Already, management has acknowledged the slowing growth, estimating new subscriber additions of just 2.5 million for the first quarter of 2022, 5.9 million below the average gain in the first quarter in the last five years.

The final verdict 

Overall, the reasons to buy outweigh the headwind from slowing growth. Netflix's stock has been cut almost in half, arguably more than pricing in slowing growth. Meanwhile, it's still the undisputed leader with over 200 million subscribers and is expanding profits exponentially. 

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

Parkev Tatevosian has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns and has recommended Netflix. The Motley Fool Australia has recommended Netflix. 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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