Why Netflix Stock Dropped on Friday

Key Points

• Netflix beat easily on earnings last night, and barely edged out sales expectations as well.

• Operating margins improved mightily in Q2 versus a year ago, but management warned of smaller margins for the full year.

• Netflix also guided for steady sales growth in the 15% to 16% range.

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Netflix (NASDAQ: NFLX) stock dropped 4.5% in early trading as of 9:40 a.m. ET, despite beating on earnings last night.

Heading into the report, analysts forecast Netflix would earn $7.06 per share on just over $11 billion in revenue. In fact, Netflix earned $7.19 per share on just under $11.1 billion, thus beating on both top and bottom lines.

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Netflix Q2 earnings

Sales increased 16% year over year in Q2, and Netflix delivered a terrific 34% operating profit margin, up nearly seven full percentage points from a year ago. On the bottom line, this translated into a 47% improvement in net earnings for the streaming entertainment star. Free cash flow nearly doubled to $2.3 billion -- not quite as good as the $3.1 billion in "net income" Netflix claimed, but still impressive.

Netflix cited the success of multiple streaming series, including Squid Game S3, Sirens, Ginny & Georgia S3, and The Eternaut, as contributing to its results. Perhaps more important though is that Netflix completed the rollout of its Netflix Ads Suite, its own proprietary first-party adtech platform, "across all our ads markets."

Is Netflix stock a buy?

Turning to guidance, Netflix said it's on course to do anywhere from $44.8 billion to $45.2 billion in revenue this year (which is more than it previously promised). Operating profit margins could be weaker than what we saw in Q2, however -- perhaps only 30% for the year -- which would diminish the impact of the 15% to 16% revenue growth.

The big question for investors now is whether mid-teens earnings growth (and relatively weak free cash flow) will be good enough to maintain Netflix's pricey 60x trailing earnings P/E ratio? This morning, at least, investors seem to be voting with their feet: No.

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Rich Smith 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.