3 reasons to buy Netflix, and 1 reason to sell

The company is in better shape than the massive sell-off indicates.

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

Netflix's (NASDAQ: NFLX) first-quarter earnings report led to a massive one-day share decline. Weak subscriber numbers had investors fleeing the stock, and a poor outlook for adding customers led to a single-day drop of 35%.

But amid the negativity, other numbers indicate that the drop might offer an opportunity to long-term investors. The question is whether those advantages outweigh a glaring weakness that showed up in the subscriber numbers of the entertainment stock. Here are three reasons to buy Netflix and one reason to sell.

1. Valuation

The drop in the stock price following earnings slammed tech investors across the board. Amid a slight decline in its subscriber base compared with the fourth quarter, Netflix stock wiped out more than four years' worth of gains.

However, its price-to-earnings (P/E) ratio now stands at 20. This is a valuation it has not seen in nearly 10 years. Its multiple is now more comparable to that of Comcast and Warner Bros. Discovery, which sell for 15 and 14 times earnings, respectively.

Moreover, it has become significantly cheaper than Disney (now at 72 times earnings), and it is a radical change from the pre-pandemic days when Netflix typically sold for a P/E ratio of over 100.

2. Financials

And while it does not post the rapid growth of past years, its financial performance remains solid. Revenue of just under $7.9 billion grew 10%. Despite the sequential drop in subscribers, subscriber numbers still rose 7% year over year to just under 222 million.

In contrast, net income dropped by more than 6% in that period to just under $1.6 billion. However, it increased spending on technology development and general and administrative expenses while its interest and other income dropped.

Additionally, Netflix had cash-flow challenges in past years as it had to run up debt to cover content development costs. Nonetheless, first-quarter free cash flow came in at $802 million, 16% higher than 12 months ago. Also, total debt fell by $858 million over the same period, adding strength to its balance sheet.

3. A robust outlook

For all of the concerns about its outlook, its problem came from not meeting investor expectations. Indeed, the forecast of a decline in subscribers of 2 million looks disappointing on the surface.

However, the company still forecasts 10% year-over-year revenue growth. This comes from a cost increase that will take its standard plan from $13.99 per month to $15.49 per month. It also plans a lower-cost, ad-supported option to attract customers who think its current service costs too much, and a move into gaming could increase interest in the platform.

Although analysts forecast a 3% dip in net income for the year, they also believe it will grow by 15% in 2023. Thus, they see its current struggles as temporary.

The reason to sell: A weakened competitive moat

The biggest challenge now for Netflix hinges on whether it has lost its competitive advantage. The company has a history of strong strategic decision-making. Netflix pioneered the streaming industry, and when competitors emerged, it pivoted to proprietary content.

That allowed it to attract subscribers in over 190 countries and helped win awards for its programming. This made streaming the mainstream (pun intended) of television. Now, numerous streaming channels exist, and the major ones offer their own proprietary content.

Indeed, Netflix's pivots into gaming and ad-supported content could draw subscribers. But without a compelling vision for the future that excites users, its high-growth era could now be over.

Should you consider Netflix?

With a discounted P/E ratio and the prospects of continued revenue growth in the double digits, Netflix might again look like a buy. Despite the competition, viewers continue to tune in to its programming. Also, with rising cash flows, the company could finance a move in a new direction.

But the uncertainty of that direction will likely remain a headwind for the foreseeable future. While Netflix may again beat the market, investors should not expect to see growth numbers comparable to past years.

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

Will Healy 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 and Walt Disney. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has recommended Comcast and Discovery (C shares) and has recommended the following options: long January 2024 $145 calls on Walt Disney and short January 2024 $155 calls on Walt Disney. The Motley Fool Australia has recommended Netflix and Walt Disney. 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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