Why Netflix Stock Sparkled in Turbulent Q3 For The Market

The third quarter of 2022 will be one to forget. The S&P 500  (SPY) – Get S&P 500 ETF TRUST ETF Report had already been suffering from high inflation, rising rates, and slowing economic growth in the first half of the year. Dip buyers were then stabbed in the back: US stocks sank another 5% in Q3.

The good news came from the battered streaming space. Netflix stock  (NFLX) – Get Netflix Inc. Report, for example, ended the three-month period up, not down, by an impressive 35%. Old-time shareholders of the streaming giant, however, are still down a painful 60% YTD.

Below, I explain why shares of the Los Gatos, California-based company did so well between July and September. Also: could the outperformance last through the end of 2022?

Figure 1: Why Netflix Stock Sparkled in Turbulent Q3 For The Market

Figure 1: Why Netflix Stock Sparkled in Turbulent Q3 For The Market

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(Read more from the MavenFlix: Should You Buy Disney Stock Today? A Fundamental View)

Netflix surges on bargain hunting

I find it hard not to think that dip-buying was an important bullish force for Netflix stock in Q3.

The company has been facing challenges lately. Margin pressure has been a feature of the business model, which relies on expensive content creation. Worse yet was a slowdown and eventual reversal in subscriber growth that slashed valuation multiples.

The chart below shows Netflix’s P/E skydiving from highs of 90x in 2020 to lows of 15x as recently as July 2022.

Figure 2: Netflix's P/E ratio.

Figure 2: Netflix’s P/E ratio.

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At some point, too low has to be low enough a price for dip buyers to pay attention. At the worst of the pullback, in May 2022, NFLX had corrected a whopping 76% from the November 2021 peak. The price had changed little by mid-July when it finally started to shoot higher.

Fundamentals improve too

But mere bargain hunting is probably not enough to explain NFLX’s impressive performance in Q3. Why, for example, did it climb in the past three months but not in Q2, when the stock price had already corrected quite a bit from the top?

The first catalyst was the Q2 earnings season, which started in July. Netflix did not deliver particularly impressive revenue growth and EPS numbers, but the underlying drivers of the business looked to be improving. Seeking Alpha summarized it well, in one short paragraph:

“Subscriber numbers. Plans for launching an advertising-supported membership option. Efforts to monetize the sharing of its members’ passwords.”

Keep in mind that the core of most investment theses until recently had been Netflix’s ability to grow its subscriber base in the home country and abroad. With the end of the COVID-driven, stay-at-home tailwinds, the company needed a new narrative. And it now seems to have one.

Is Netflix in the clear?

Let’s imagine for a moment that Netflix will thrive in the streaming space (it already has been, as the dominant name in the industry) and that, eventually, NFLX stock will return to all-time highs. Merely getting there suggests upside potential of nearly 200%, cumulative.

Investors don’t even need shares to climb to the peak very fast. If full recovery happens over three years, for instance, the return expectation would be 43% per year, which is quite impressive.

This is not to say, however, that NFLX is in the clear. First, there is no guarantee that the company’s turnaround plans will work, and that the stock will react positively as a result.

Peer Spotify  (SPOT) – Get Spotify Technology S.A. Report comes to mind. This stock still trades well below the 2018 IPO price of $132, despite the company being a global leader in audio streaming.

Second, Netflix can still revisit lows. This is particularly true if stocks at large continue to struggle – the S&P 500 ended Q3 down an uncomfortable 5%. History has taught us that, in the short term, relative winners tend to suffer in a bearish environment when traders rush to lock in profits.

I like Netflix as a streaming service provider, but I have reservations about the business model and the stock. I would warn investors to expect volatility in the short term, and I believe that buying NFLX after a 30%-plus run in Q3 can be a bit speculative.

Ask Twitter

Netflix stock had an outstanding Q3 of 30%-plus gains while the S&P 500 struggled for the third consecutive quarter. What do you think happens to NFLX next?

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(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting the MavenFlix)

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