Netflix Stock Downside Scenario: $400

Netflix (NASDAQ:NFLX) stock has had a solid year, rising by almost 60% year-to-date as the company successfully navigated a brief subscriber decline post-Covid-19. This compares to rival Disney (NYSE:DIS), which has gained a mere 5% over the same period. However, despite Netflix’s recent success with its crackdown on password sharing and the expansion of its ad-supported streaming option, there are some risks facing the company. Could Netflix’s stock fall to levels of $400 in the next few years, compared to its current level of around $750? It’s possible given Netflix stock’s considerable volatility. Returns for the stock were 11% in 2021, -51% in 2022, and 65% in 2023. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, is considerably less volatile. And it has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics.

In this analysis below, we take a closer look at Netflix’s revenues, margins, and earnings multiples to explore a potential scenario where the stock could fall. This serves as a counterpoint to our previous analysis of Netflix Stock: The Road To $1,000 Much like Netflix has revolutionized the entertainment business, Intuitive Surgical (NASDAQ: ISRG) is disrupting the surgical business: ISRG Stock To $5,000?

Netflix’s growth may cool considerably 

Netflix’s revenue growth has been on a relatively strong trajectory with sales rising from about $20.16 billion in 2019 to $33.7 in 2023, translating into an annual growth of about 14% each year. Revenues are projected to grow at about 15% in 2024 to almost $39 billion. However, there is a real possibility that growth could slow meaningfully going forward, possibly to low or mid-single-digit levels. Why is that?

A bulk of Netflix’s growth in recent quarters has come via strong subscriber growth with the company adding over 50 million subscribers between early January 2023 and September 2024, taking its user base to about 283 million. Netflix started putting restrictions on password-sharing last year, which forced people using someone else’s account to create their own accounts or sign up for paid sharing of accounts to continue using Netflix. While this crackdown on account sharing boosted subscriber numbers, the impact may be short-lived. With the policy now enforced in over 100 countries, there may be relatively limited growth that can come from this avenue. We wouldn’t be surprised if paid sharing pulled forward potential subscribers from outer years, possibly reducing future growth. In fact, Netflix’s paid net additions have been slowing down of late. Paid additions in the U.S. and Canada stood at 0.69 million in Q3, down from 2.5 million in Q1 and about 1.5 million in Q2.

Netflix ARPU growth could also falter going forward. Netflix has already raised prices several times in recent years, with its most popular ad-free plan rising from $10 in 2017 to $15.50 today. While Netflix has skillfully monetized users without increasing churn driven by its strong content slate and recently added advertising revenue streams, the competition is mounting. For example, Disney’s streaming bundles, offering Disney Plus, Hulu, and ESPN Plus for as low as $15 per month, provide stronger value, potentially leading to lower churn and higher sign-ups for Disney.

Sure the streaming market isn’t a zero-sum game with many users subscribing to multiple services. However, the increasingly competitive environment, along with a challenging economic outlook and weaker consumer spending, gives Netflix less room to raise prices. Netflix has also avoided raising the price of its standard full-HD plan since its last increase in January 2022, suggesting a relatively cautious approach to pricing.

Given the possibility of slower subscriber growth and limited ARPU gains, Netflix’s revenue growth could slow significantly. From an estimated $39 billion in 2024, we see a scenario where growth might only average around 5% over the next three years, bringing total revenue to approximately $45 billion by 2027.

Net profit margins could contract

Netflix has expanded its net margin from levels of about 9% in 2019 to about 16% in 2023 and margins are projected at about 22% for this year, translating into a net profit of about $8.7 billion led by a higher customer base as well as better cost management. However, costs could tick upward in the coming years.  Netflix is also now offering more live content including notable sports programming. Netflix is set to stream Christmas NFL games this year as well as WWE Raw wrestling starting Jan 2025. Sports rights often come with sizable costs and it could take time for Netflix to optimize its cost structure to absorb these expenses, without hitting margins.

Moreover, free cash flows have been low or negative for the last several years due to elevated content spending. For example, between 2019 and 2022, Netflix generated a total of less than $300 million in free cash flows for the four years, although the number picked up to over $6.9 billion in 2023 as the strikes by writers and actors reduced the company’s content spending to just about $13 billion in 2023, down from around $17 billion in the previous year. Content spending is expected to pick up again in 2024 to around $17 billion. If content cost pressures persist, while Netflix also faces slowing growth after the big bump from ad-supported plans and paid sharing, there remains a possibility that net margins could fall back to levels of roughly 20%. This could translate into net profits of just about $9 billion by 2027, a mere 3% higher than projected 2024 levels.

Investors will rethink Netflix’s lofty earnings multiple 

At the current stock price of about $750 per share, Netflix trades at around 37x forward earnings, which appears expensive in our view. Although Netflix’s recent performance has been strong, markets tend to be short-sighted, extrapolating short-term successes for the long run. In Netflix’s case, the assumption is that the company will continue its strong streak of subscriber additions and likely grow revenues comfortably at double digits. However, there’s a real possibility that Netflix will soon see subscriber growth cool, as the twin benefit of the password-sharing crackdown and ad-supported tiers is likely to eventually stabilize.

If Netflix’s P/E multiple declines to levels of about 20x by 2027, with potential net earnings of about $9 billion calculated previously, this would translate into a market capitalization of about $180 billion, or a little over $400 per share. Now while such a decline in P/E multiple may appear drastic, Netflix stock typically reacts very sharply to news.  The stock has seen drawdowns of over 70% in a matter of a couple of months, like the sell-off that came between October 2021 and May 2022 when the company witnessed a post-Covid slowdown.

What about the time horizon for this negative-return scenario? While our example illustrates this for a 2027 timeline, in practice, it won’t make much difference whether it takes three years or four. If the scenario plays out, with Netflix seeing slower subscriber adds coupled with stalling ARPU growth, the stock could see a meaningful correction. See our analysis Netflix Valuation: Expensive or Cheap for more details on what’s driving our price estimate for Netflix.

[1] Returns as of 10/29/2024
[2] Cumulative total returns since the end of 2016

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