Despite Selldown, Netflix May Be Worth Keeping on Your Watchlist


New Industry Paradigm Assumption

Industries move through a series of stages as they evolve, each with their general characteristics. Growth companies tend to exhibit the following:

  1. Products that consumers know.
  2. There is a demand for the product.
  3. Price declines are evident as industry efficiencies occur.
  4. Competitors enter the industry; however, the "pie" is big enough to limit rivalry.

Before lockdown, the streaming video entertainment industry was in the growth stage. Coming out of lockdown, likely, this is still the case. However, we offer an alternative hypothesis. The hypothesis assumes that the industry has now moved from the growth phase to the next stage – the shakeout phase. The supposition here is that lockdown accelerated the growth phase. I.e., as lockdown ensued, the increased demand for streaming services caused an exogenous shock which effectively amplified the four points above, leading to a much shorter growth phase.

The shakeout phase has the following characteristics:

  1. Growth starts to decline.
  2. Demand for the product moderates.
  3. Rivalry is intense and leads to pricing constraints.
  4. Cost control becomes a significant focus for management.
  5. Firms operating in the industry adapt or disappear.

NFLX's Fundamentals

Return on Equity (ROE) and its Breakdown
Over the last decade, NFLX's ROE has grown from 2.31% to 32.28% (red dashed line). Therefore, the analysis of the breakdown of ROE over this period is informative. In this regard, consider the stacked column chart below:

  1. The blue element shows the company's financial leverage. This has reduced significantly in relative contribution to ROE. It is currently at its lowest over the period, in absolute and relative terms. As such, NFLX has more robust solvency.
  2. The yellow element shows total asset turnover. This contracted to its lowest value in 2019 (59.33%). The current reading improved to 66.61%. Moreover, on a relative basis, total asset turnover contributes more to ROE.
  3. The green element shows NFLX's operating margin. This has improved over the period, suggesting more control over variable costs. Its contribution to ROE on a relative basis has improved as well.
  4. The orange and purple elements are the interest and tax burdens, respectively. Again, NFLX has improved in these areas and is retaining more profit after making these payments. Together there has been a significant improvement on a relative basis over the period, making substantial contributions to ROE.


Past Performance: Past Performance is not an indicator of future results.

Revenue vs. Free Cash Flow (FCF)
As a company develops, like any industry, it moves through stages too, from start-up-->growth-->mature. Revenue tends to be positive from some point in the start-up phase, but cashflows tend to be negative. As it moves into the company (not industry) growth stage, revenues rise, and cash flows improve. Consider the chart below:

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  1. The blue line shows rising revenues.
  2. The orange line shows NFLX's free cash flow. Between 2019 and 2020, it briefly moved positive before stalling. In the company's Q4 shareholder letter it states, "We anticipate being free cash flow positive for the full year 2022 and beyond."


Past Performance: Past Performance is not an indicator of future results.

Cash From Investing
Most assets are content-related, intangible, and, importantly are, new assets. The current cash from investing activities (CFI) shows $1.3bn was invested, with a sharp increase of 165% over fiscal 2021.


Past Performance: Past Performance is not an indicator of future results.

Intangible Fixed Assets Turnover
Both revenue (blue columns) and net intangible assets (orange columns) have increased significantly in the chart below. However, the intangible fixed assets turnover decreases markedly (white line chart). At first glance, this is troubling. However, we refer to the kink downwards in the white line for 2020. This is due to the significant increase in investments made by NFLX over the 2021 fiscal period. I.e., the ratio is low precisely because of the new content acquisitions. In addition, there has been hardly any amortization of the intangible asset total that has needed to take place. This means there is considerable potential for this ratio to kick up once amortization occurs and revenue generates from the assets.


Past Performance: Past Performance is not an indicator of future results.


If streaming video entertainment has moved into the shakeout phase:

  1. NFLX's ROE is of a much higher quality than previous.
  2. Its free cash flow is on the cusp of turning positive.
  3. It has invested heavily in its future.
  4. It is a value-creating business as per our estimates of its return on invested capital (green columns) vs. its cost of capital (red columns). I.e., the blue value creation line (ROIC-WACC) has turned up:


Past Performance: Past Performance is not an indicator of future results.

Market sentiment is risk-off. There are geopolitical concerns between Ukraine and Russia, and central banks are tightening. The market was also disappointed by NFLX's forward guidance. However, this may be an overshoot. Therefore, we are looking for calm before conducting a technical analysis regarding if and when potential entry points present themselves.

Featured Image by Andrés Rodríguez from Pixabay

Russell Shor

Senior Market Specialist

Russell Shor joined FXCM in October 2017 as a Senior Market Specialist. He is a certified FMVA® and has an Honours Degree in Economics from the University of South Africa. Russell is a full member of the Society of Technical Analysts in the United Kingdom. With over 20 years of financial markets experience, his analysis is of a high standard and quality.


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Past Performance: Past Performance is not an indicator of future results.

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