Netflix has truly taken investors on a wild ride in the past year. At this time last year, Netflix stock was approaching $500 for the first time. But by the end of 2014, shares had plummeted to nearly $300 after third-quarter subscriber growth fell short of expectations and Netflix projected domestic contribution margin growth would slow beginning in 2015.
As it turns out, this was a false alarm. Netflix's third-quarter performance was a fluke, and growth has accelerated again both in the U.S. and abroad, making the video streamer the best-performing stock in the S&P 500 for 2015. This culminated with Netflix's official announcement that it would implement a seven-for-one stock split this month, which briefly pushed the stock above $700 (though it has since given up some ground).
Netflix 1 Year Stock Chart, data by YCharts.
Given the stock's volatile history, investors have to be wondering whether Netflix's recent success is sustainable. What does Netflix need to do to keep the stock moving higher?
International growth: promising, but still plenty of question marksNetflix's international expansion has attracted plenty of press coverage and investor attention lately. To some extent, this is understandable. Netflix has been rapidly adding new markets, and it surpassed 20 million international subscribers in the first quarter (up 65% year over year).
On the other hand, Netflix will continue losing money in its international markets for at least a few more years due to the rapid pace of expansion. It's not clear what the breakeven point for Netflix's international operations will be -- other than that it will be much higher than in the U.S.
Furthermore, while the U.S. economy is in fairly good shape, Netflix might have to contend with weak macroeconomic conditions in many foreign markets for the foreseeable future. The strong dollar makes matters worse by diluting the value of Netflix's non-dollar-denominated revenue.
It's also hard to know at this point how profitable international markets will be in the long run. This means there's no straightforward way to evaluate just how much the global business is worth. Netflix's strong international subscriber growth is promising, but that's about all that can be said with any degree of certainty.
It's still all about the U.S.By contrast, two aspects of Netflix's domestic results over the next year or so could reveal much about the company's value.
First, will domestic subscriber growth slow? A year ago, Netflix claimed that increasing the price of its most popular plan by $1 per month for new subscribers had a minimal impact on subscriber additions. A few months later, Netflix executives were talking about higher prices leading to somewhat slower growth. A few months after that, Netflix instead blamed the slowdown in growth on higher saturation of the U.S. market. And by April 2015, the slowdown looked like just a blip, as growth reaccelerated.
Netflix's strong content library has kept its domestic subscriber base growing. Photo: The Motley Fool.
In short, even Netflix's management doesn't have a clear understanding of where the company is on the adoption curve in the U.S. A few more quarters of data won't be decisive, but it could still bring additional clarity about Netflix's likely future subscriber growth trajectory.
Netflix has added nearly 6 million U.S. subscribers in the past year and ended the first quarter with 41.4 million domestic subscribers. Based on those numbers, it would be shocking if Netflix couldn't hit the bottom of its long-term U.S. subscriber target range of 60 million-90 million.
Reaching the top of the range will be much tougher. Netflix's success in the next year will say a lot about whether it can get there, despite competition in the streaming-video space heating up.
Second, can Netflix maintain its recent track record of strong margin expansion in the U.S.? Late last year, management told investors to expect its domestic streaming contribution margin to rise by 200 basis points per year going forward.
Yet in April, Netflix reported that its domestic contribution margin had jumped by a stunning 370 basis points just in the first quarter. Netflix has publicly adhered to its standing guidance that the domestic contribution margin will reach 40% by 2020. If that starts to look overly conservative, it could mean Netflix's long-term earnings power will be even higher than bulls currently expect.
Any more surprises?Netflix has delivered plenty of surprises to investors in the past few years: some good and some bad. Today, investors expect so much from the company that there is probably a bigger risk of Netflix missing expectations than blowing them away.
More specifically, a sharp slowdown in domestic subscriber growth -- such as what occurred in the second half of 2014 -- could cause Netflix stock to fall hard. Netflix probably needs to reach the upper half of its long-term domestic subscriber target range to justify its current valuation; another growth slowdown would cast doubt on its ability to get there.
Additionally, Netflix has a large amount of expensive content in the pipeline, so slower subscriber growth could put a quick halt to its strong margin expansion trend, reducing profit growth.
Netflix investors have to hope they don't get any surprises like this. Even strong international subscriber growth would be unlikely to make up for any problems in the domestic market.
Check back next week for a more detailed analysis of what investors should look for when Netflix reports its second-quarter earnings later this month.
The article What's Next on Netflix's Wild Ride? originally appeared on Fool.com.
Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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