Investors may want to use the recent pessimism on the stock market to their advantage.
Investors have been hit by some turbulence in recent days. Weak US economic data, an interest rate hike in Japan and Berkshire-HathawayAggressive sales have led to significant declines in the past week S&P500 and the Nasdaq-Composite Index.
But smart investors know that volatility is par for the course when it comes to generating solid long-term returns. In fact, the sell-off could present lucrative opportunities in otherwise fantastic companies, like this streaming pioneer, whose shares have fallen 10% since their 2024 peak (as of August 6).
Should investors buy this phenomenal stock when the price drops?
Dominance in the new media landscape
Investors who want to get involved in Netflix (NFLX 0.57%)the leading pure-play streaming company, may want to take advantage of the pessimism in the market. There are a few reasons to like this company.
Let’s start with Netflix’s first-mover advantage. Its lead in the streaming race helped the company gain customers quickly and grow revenue disproportionately. Netflix was able to gain subscribers in a spectacular way because it offered a better user experience compared to traditional cable TV.
Of course, the streaming industry is much more competitive today. But Netflix is the undisputed winner. As of June 30, the company had 278 million members in over 190 countries. Netflix has become a global media and entertainment giant with economies of scale.
Admittedly, growth will slow down, even though management expects Total target market Opportunity (who are not currently Netflix customers) to reach 500 million smart TV households worldwide. In its most mature markets, the US and Canada, Netflix has been able to successfully leverage its pricing power in the past.
Due to its size, Netflix generates high revenue, amounting to $36 billion in the last 12 months. This allows the company to spend heavily on content production and licensing while also seeing increasing profitability. The company expects an operating margin of 26% this year, which would be better than last year’s 21% and the 18% in 2022. Netflix is clearly showing the benefits of its scalable business model while its competitors are struggling with profit growth.
Because Netflix invested so much money in the 2010s to acquire subscribers and develop its content offering, critics didn’t believe the company would generate positive free cash flow (FCF). However, Netflix has proven the doubters wrong. The company generates billions of dollars in FCF and uses some of it to buy back stock.
Do not ignore the review
It is rare that the shares of such a dominant company are offered for sale. In May 2022, Netflix shares were sold for a Price-earnings ratio (P/E) of 15, which is unheard of. In addition to the general market weakness amid rising interest rates, investors were concerned about Netflix’s subscriber losses in the first quarter of 2022. However, in hindsight, this turned out to be a wonderful buying opportunity.
Netflix stock is not nearly as cheap today. It is trading at a price-earnings ratio of 39. On the surface, that does not look convincing. It represents a premium of 25% over the Nasdaq-100 Index. However, it is much cheaper than the average valuation multiple over the last five or ten years.
It’s also worth noting that Netflix’s earnings per share (EPS) have grown 52% annually over the past five years, and according to Wall Street analyst consensus estimates, EPS is expected to grow 32% annually between 2023 and 2026.
With shares down 10% since their 2024 peak, it seems like a good time to take advantage of the dip and add Netflix to your portfolio.
Neil Patel and his clients do not own any stocks mentioned. The Motley Fool owns positions in and recommends Berkshire Hathaway and Netflix. The Motley Fool has a disclosure policy.
