Billionaire Bill Ackman Just Invested in Netflix Stock. Here's Why Investors Should Care.

As a student of Warren Buffett, Bill Ackman has operated his hedge fund, Pershing Square Capital Management, with a concentrated portfolio of what he believes to be high-quality businesses. The billionaire frequently publicizes his firm's thinking. This provides valuable insight for individual investors looking at potential places to allocate their capital.

During the second quarter, Ackman's fund acquired 13.1 million shares in Netflix (NASDAQ: NFLX). As of June 30, the streaming stock represented less than 5% of the entire portfolio, which doesn't make it a top-10 position. This is still a notable purchase given that Netflix shares currently trade 42% off their peak (as of Aug. 14).

Here's why investors should care about Bill Ackman's latest move.

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Be critical of the hedge fund manager's timing

This isn't Pershing Square's first time betting on Netflix. In January 2022, the fund purchased a split-adjusted 31.1 million shares in the company. By late April of that year, it had sold off the entire stake, booking a significant $400 million loss.

At the start of 2022, Ackman's view of Netflix was straightforward. His firm appreciated the company's recurring revenue stream, management team, scale advantage, pricing power, and cash profits. And the stock was bought at what he perceived as a very compelling valuation at the time, at a forward price-to-earnings (P/E) ratio of around 38. At first, this looked like it would be a home run investment.

When Netflix reported Q1 2022 financial results, the company revealed its subscriber base shrank by 200,000 that quarter. This was a troubling development, even though hindsight proved that it was a period of normalization following a pandemic-fueled demand surge. Netflix is much larger today.

However, this short three-month holding period in early 2022 should force investors to be critical of Ackman's timing and conviction. Hedge fund managers with a long-term time horizon and concentrated books, who have certainly taken the time to conduct thorough research, shouldn't react to one bad quarter by immediately dumping their whole positions. Being able to hold through the losses with patience is key.

Since the day after Netflix's disappointing 2022 first-quarter financial update, the stock has skyrocketed 246%. Maybe this suggests that Pershing Square lacks the ability to always buy and sell at the right time.

Understand the investment thesis

Netflix has "won the streaming wars," the hedge fund's Q2 2026 shareholder letter reads. The investment thesis focuses on some important areas.

The company's scale is a huge advantage, demonstrated by more than 325 million subscribers and forecast 2026 revenue of $51.2 billion. This allows Netflix to spend more on content than its peers do in absolute terms. But the business can spread out these costs over its sales base, leading to robust profitability and free cash flow.

Ackman calls out how, since 2021, cash content spend has risen at just 2% annually. At the same time, the operating margin went from 21% to 31.5%. Additionally, the firm emphasizes the successful launch of the ad-based membership tier, which attracts price-sensitive customers in foreign markets.

At a high level, there are essentially two powerful catalysts that Pershing Square believe will drive the streaming stock's returns. The first is valuation, with shares trading at a forward P/E ratio right now of 24.2. The other tailwind is the hedge fund's projection that Netflix's earnings per share will grow at an annualized pace of 19% over the coming three to five years.

Know the most important risk Netflix faces

Investors shouldn't ignore risk factors that can impact the Netflix thesis. The most notable comes from competition. This not only includes direct rivals, but it also points to social media platforms that are experiencing surging viewership. There's only so much time people have in a single day. Netflix has to fight harder than ever before to draw more eyeballs to its service.

A more crowded industry is showing up in the company's growth figures. The consensus view among analysts is that Netflix's revenue will increase at a compound annual rate of 11.6% from 2025 to 2028. This is a deceleration from the pace of the prior three years, and it's a far cry from the more than 20% yearly gains of the 2010s. This trend points to a new reality for the business.

Investors looking to follow billionaire Bill Ackman's bet on Netflix stock have a lot to think about.

Neil Patel 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.