Netflix: Record Buybacks, Rising Margins, and a Slate in Need of a Refresh

Netflix (NASDAQ: NFLX) shares fell 8% after its second-quarter report on July 16, yet the streaming giant is on pace for its most profitable year ever. The company spent nearly $5 billion on stock buybacks, its largest quarterly repurchase activity on record, and management reloaded its buyback authorization to $27 billion.

All of this comes at a time when investors appear disinterested, even as shares trade for less than 20 times earnings. The stock is down nearly 50% from last year's high, weighed down by a valuation rerating and concerns that user engagement is softening against rising competition from short-form video, podcasts, gaming, and other streamers.

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A maturing model

Management argued on the earnings call last week that raw viewing hours don't tell the whole story, and its Q2 shareholder letter described engagement as healthy. Management continues to expect revenue growth of 13% to 14% and an operating margin of 31.5% for the full year. That's more than 1,000 basis points of margin expansion over the past three years.

The company's cash flow profile is strengthening as revenue growth outpaces content spending growth. Free cash flow is expected to grow by more than 30% this year to $12.5 billion, up from previous guidance of $11 billion, as margins continue to expand. Given the stock's performance of late, long-term Netflix shareholders are understandably left scratching their heads.

Management also noted that recent price increases in key markets, such as the U.S. and Mexico, have "gone well." The $8.99 ad-supported subscription plan provides an affordable entry point, and the company expects ad revenue to roughly double to $3 billion in 2026. That's still just 6% of revenue, but it carries higher incremental margins than the core subscription business, giving the margin story more room to run.

The battle for attention

Concerns surrounding user engagement were circulating heading into the report. On the earnings call, management pushed back on these concerns, arguing that engagement had improved slightly in the first half of the year. Still, the company's decision to move its detailed engagement report from a semi-annual to an annual release raises questions, especially after it stopped reporting subscriber metrics last year.

The rising competition for eyeballs and content quality are factors that have weighed on the stock. According to Nielsen, YouTube now captures roughly 13.5% of U.S. television viewing, well above Netflix's estimated 8% share. Netflix competes for viewing time, not only with other streamers, but with free alternatives like short-form video and podcasts.

More importantly, the consumer market for artificial intelligence (AI) is still in the early innings, creating further uncertainty around what the competitive landscape will look like in a few years.

That said, at 19 times forward earnings, the risk/reward has shifted. The stock hasn't been this attractively priced in a long time. While the engagement story is far from settled, a high-quality platform like Netflix is worth investing in at a below-market multiple.

Bryan White has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Netflix. The Motley Fool has a disclosure policy.