Netflix’s Stock Surge Raises Concerns About Future Growth

Netflix (NASDAQ:NFLX) stock has experienced a remarkable increase, climbing nearly 72% year-to-date. The company effectively managed a temporary drop in subscribers following the Covid-19 pandemic. Currently, shares are trading just below $840, largely driven by its successful strategies against password sharing and the introduction of advertising-supported streaming. In contrast, Disney (NYSE:DIS) has seen only a modest 5% increase over the same timeframe. Given that Netflix is at an all-time high, investors may wonder if this presents too much risk.

Netflix Stock Volatility: A Historical Perspective

Historically, Netflix stock has shown significant variability. In 2021, it returned 11%, but this dropped to -51% in 2022 before rebounding with a 65% return in 2023. For comparison, the Trefis High Quality (HQ) Portfolio—a selection of 30 less volatile stocks—outperformed the S&P 500 each year during this period. This portfolio provided returns with reduced risk, diverging from Netflix’s much more tumultuous performance.

Subscriber Growth Faces Limitations

Recent growth for Netflix can be attributed to a sharp increase in subscribers, with over 50 million added between January 2023 and September 2024, bringing the total to about 283 million users. The company’s policy to limit password sharing—implemented last year—required users on shared accounts to create their own subscriptions ($8 for add-on subscribers) to keep using the service. Although this policy initially boosted subscriber growth, its effectiveness may be short-lived. Now enforced in more than 100 countries, the potential for further subscriber gains may be limited.

Potential Slowdown in Ad-Supported Plans

The trend might also apply to Netflix’s ad-supported plans. The company reported that over half of new subscribers in markets with these options are choosing ad-supported tiers. Yet, this initial influx may not translate into sustained growth. Analysts worry that paid sharing and ad-supported subscriptions might merely pull forward potential subscribers who would have joined in the future. In Q3 2024, Netflix recorded only 0.69 million paid additions in the U.S. and Canada, significantly down from 2.5 million in Q1 and 1.5 million in Q2. Additionally, Netflix’s decision to stop disclosing its subscriber numbers starting in 2025 may indicate a recognition of slowing growth prospects.

Challenges to Pricing Power and Profit Margins

Growth in Netflix’s average revenue per user (ARPU) could also stall. The platform has raised prices multiple times recently, with its most popular ad-free plan increasing from $10 in 2017 to $15.50 today. Though Netflix has successfully monetized its content without losing subscribers, competition is intensifying. Disney’s streaming bundle, offering Disney Plus, Hulu, and ESPN Plus for just $15 monthly, provides a strong alternative. Economic pressures may lead to higher cancellation rates or prompt users to switch between services.

Niche streaming services have also gained popularity, attracting users with specialized programming such as British TV and anime. In this competitive landscape, alongside economic challenges, Netflix has limited opportunities to increase prices. Notably, the company has not raised the price of its standard full-HD plan since January 2022, reflecting a cautious approach to pricing adjustments.

Forecasting Netflix’s Financial Future

Netflix’s profit margins may also face pressure. Although net margins have grown from 9% in 2019 to approximately 22% in 2023, rising content costs, particularly with the addition of live sports programming like NFL games and WWE wrestling, could impact profitability. Following a temporary drop in content spending amid 2023’s writers’ and actors’ strikes, Netflix plans to invest around $17 billion annually in new content. Should subscriber growth decelerate while costs increase, Netflix’s margins could narrow, possibly slowing profit growth.

Valuation at Current Stock Prices

At nearly $840 per share, Netflix trades at around 42 times expected 2024 earnings, which may seem steep. For context, shares were priced at roughly 20 times earnings in mid-2022. Despite recent strong performance, markets often focus on short-term gains, projecting continued growth in subscriber numbers and revenue. However, with the combined effects of password-sharing restrictions and ad-supported tiers likely reaching their peak, future growth could stagnate. If this occurs, Netflix stock may experience a significant drop, indicating a higher risk for potential investors. Our analysis values Netflix stock closer to $613 per share, indicating a 25% downside risk based on current prices.

[1] Returns as of 11/15/2024
[2] Cumulative total returns since the end of 2016

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.