Why the Latest Earnings Show Netflix Plays by Its Own Rules

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Netflix (NASDAQ: NFLX) unveiled its fourth quarter and full-year 2017 financial results last week with investors cheering record subscriber additions.

On this episode of Industry Focus: Consumer Goods, the team discusses the core numbers they watch at Netflix and the intricacies of evaluating a company that makes sacrifices on the bottom line in exchange for impressive growth.

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A full transcript follows the video.

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This video was recorded on Jan. 23, 2018.

Vincent Shen: Netflix unveiled its fourth quarter and full-year 2017 report after market close yesterday, that was January 22nd. Before we dive into the actual results, Danny, I think it would be helpful for listeners to get some context and insight into what you usually focus on when you're deciphering Netflix earnings. So before we go to the actual report and those results, what were you watching and hoping to see?

Danny Vena: Every company is a little bit different, and Netflix has essentially created their own market. Their streaming didn't exist before a decade ago. They pioneered the concept. And they also pioneered the concept of the low-price subscriber model, month after month of video entertainment, initially with the DVDs.

Shen: Absolutely.

Vena: So because of that, and because they're such a high-growth company, watching some of the normal metrics really doesn't give you the information you need to have. Netflix wants you to watch their profit margins and their subscriber growth. Personally, I still keep an eye on the revenue, because that gives us a little insight not into the subscriber growth but also the ASP, the average subscription price, that customers are paying. That's another lever that Netflix can pull. Back in October, they rolled out a price change in their U.S. market and across some of their major European markets. So watching the average selling prices, watching the number of subscribers both internationally and domestically, and watching the revenues, that's the attack that I take.

Shen: Awesome. It's good to have that context. The way that I look at Netflix and some of -these reports, similar to what you mentioned, you have these high-growth stock market favorites, you have to keep in mind the broader context of where the business currently stands, and what expectations it will have to live up to based on its valuation.

In the case of Netflix, we have a company that's trading at over 9x its 2017 sales, and right around 200x its earnings from that same period. That's a pretty hefty premium for investors to have to stomach. As you can imagine, expectations for the company are always high. But that's not really stopping the rally the stock has enjoyed the past five-plus years. And after yesterday's report, actually, Netflix shares, right before we came into the studio, they're up another 10% today already.

Without further ado, Danny, can you walk us through some of the bigger numbers and highlights? Some of the metrics, for example, that you mentioned that you're tracking and how the company actually fared for the fourth quarter and full-year 2017?

Vena: I think part of the reason that the stock is seeing such a big move today is because the subscriber growth not only beat analysts' expectations across the board, but it also beat Netflix's rather ambitious forecasts. Netflix was modeling for just over 6 million total subscribers, and they ended up, instead of with 6.3 million, they ended up with 8.3 million, so 2 million more than what they were looking for. And that growth was not only limited to the international subscribers, which was expected, they expected to see high growth there. But Netflix also added 2 million more subscribers in the domestic market. They were only expecting just over 1.25 million. And one of the things that does is silence the critics that say Netflix is becoming saturated in its domestic market -- 2 million more subscribers in a quarter is pretty substantial.

Shen: Yeah. I think the total count now for that domestic business is around 55 million, and the long-term projections from management, they've said that they see an opportunity around 60 to 90 million for the domestic market. So they're starting to approach that lower bound. But despite that penetration here in the U.S. market, still really impressive growth across the board in terms of that subscriber count. How about some of the other things that you were really focused on?

Vena: I was also looking at the revenue. A couple of things that stand out: Netflix met analysts' consensus estimates for revenue and earnings per share, so there were no big surprises there. They did beat a little bit on the top line of revenue. But one of the things that stood out to me was the fact that the ASP, the average subscriber price, was up 9% year over year as some of the price increases they put into effect in October started to take hold.

Shen: OK. So even with Netflix approaching about 120 million subscribers worldwide now, they're still recording very consistent double-digit growth, and there's very little doubt that the company is still firing on all cylinders in terms of its international expansion, their content pipeline -- which we'll be talking about shortly -- and also some of the prestige of the original content that it is producing.

Danny Vena owns shares of Netflix. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.

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