- Netflix has finished 2015 as the best-performing stock in the S&P 500.
- The company's impressive subscriber growth is mainly to thank for this performance.
- How will Netflix stock perform in 2016?
Netflix (NASDAQ:NFLX) has ended 2015 as the best-performing stock in 2015 with a gaudy return of 134%. In sharp contrast, PowerShares Dynamic Media ETF where Netflix stock belongs finished the year 1% down while the S&P 500 finished the year down 0.73%. Netflix stock is certainly enjoying a strong run, and Wall Street remains overwhelmingly bullish with the bulls outnumbering the bears 29 to 4.
That makes it four years in a row that Netflix stock has vastly outperformed the sector and the market. The question on top of the minds of Netflix investors right now is whether the company can maintain its impressive momentum in 2016.
Perhaps investors don’t have to look very far for an answer. The last time Netflix stock finished the year in the red was back in 2011 when the stock finished the year down 44%. Netflix stock had tanked a massive 33% despite the company beating third quarter’s earnings estimates after the company announced that it had lost 800,000 subscribers during the quarter. The massive churn was caused by Netflix charging separate prices for its core streaming video and DVD-by-mail plans resulting in a huge price hike for its customers. A flurry of Wall Street downgrades followed the announcement and investors fled for the hills.
So there you have it. The one number that counts the most for Wall Street and Netflix investors is subscriber growth. Netflix has only thin profit margins due to high content costs, and the stock can certainly make good gains if the company can improve this metric. But ultimately Netflix stock, perhaps more than any other large-cap stock, trades on how fast its subscriber base grows; the faster the better for the stock.
So in trying to forecast how Netflix stock is likely to perform in 2016 we have to try and gauge if the company can maintain its subscriber growth or even improve on it.
Most of Netflix’s new subscribers are coming from international markets. During the last quarter, more than three quarters of the new subscribers that Netflix added came from international markets. Netflix has generally been performing well in most of the new markets it has joined lately. For instance, Netflix managed to garner 80% of streaming video subscribers in Australia just 8 months after launching in the country, which clearly illustrates that the company now enjoys powerful brand recognition. Netflix recently said that it has upped the target of new markets it hopes to join over the next two years or so from 50 to 200. Netflix typically does not spend a lot on infrastructure capex so its international expansion is not likely to put a big dent on its bottom line.
Over the short-term, there is a possibility that Netflix stock might suffer when it reports its first quarter earnings on 19th Jan. There is a likelihood that Netflix did not manage to add many subscribers during the seasonally hot fourth quarter because it went through a dry patch without original content after its deal with Epix ended. But the effect is not likely to last since Netflix inked an original content deal with Walt Disney (NYSE:DIS) back in 2012 that will kick in in early 2016 and make Netflix the exclusive U.S. subscription television service for Disney’s new releases. Disney has been enjoying a whale of a time with its movie business so that should give a nice boon to Netflix.
Netflix subscriber growth is also likely to receive a significant boost after the company enters the Chinese market during the early part of 2016. Netflix will partner with a Chinese company which might make it easier to crack the Middle Kingdom.
While Netflix is likely to continue enjoying strong subscriber growth, the company is likely to face another speed bump: rising content costs. Netflix CEO Ted Sarandos spoke about Netflix’s content challenges at UBS Media Conference in early December where he said that the company is likely to face high content costs not only in the U.S. market but also abroad due to growing competition. Netflix stcok has plunged 10% since the presentation which indicates that investors did not take the comments lightly.
This is quite worrying since Netflix’s content costs now hover at around 88% of revenue. Any sharp increases might take a severe hit on the company’s already thin margins. So the performance by Netflix stock in 2016 might be tempered if the company’s content costs continue on their upward trajectory. But I believe the effect is likely to be rather muted since companies such as Hulu and Amazon (NASDAQ:AMZN) Video Prime are not very aggressive in their international expansion plans as Netflix is.
Netflix stock is likely to perform well in 2016, but not quite to the level it did in 2015 due to rising content costs and the fact that the market might begin to get jitters about the valuation of the stock. Netflix’s earnings shrunk 67% in 2015, and rising content costs is likely to make the situation even worse. At some point in the future, investors are bound to start demanding better bottom line performance and Netflix stock could suffer. But right now all eyes seem to be focused on subscriber growth which appears almost guaranteed barring a major surprise. So we can surmise that Netflix stock remains a relatively safe investment for the next two years or so.