Last week, I wrote about 3 things that I am watching when Netflix releases its Q1 2021 report on April 20th. Well, Netflix reported after the market closed on Tuesday and the stock fell 10-11% initially. Was the earnings report that bad? Let’s dig in.

Netflix management has long reiterated the goal of adding 20-30 million subscribers in each year. They added 36.57 million subscribers in 2020 and were expecting to add 6 million subscribers in Q1 2021. Instead they added only 4 million subscribers. So, they missed their estimates by 2 million subscribers. They have a total of 208 million subscribers at the end of Q1 2021. In the grand scheme of things, this is a miss of less than 1% (2/208). Does that sound like a miss that should result into a 10% drop in share price.

Funny thing is all the articles that I read were talking about the miss in subscribers numbers. Very few articles mentioned the progress that Netflix made in other metrics. The other things I was watching is revenue growth, operating margin and EPS growth. Let’s see how Netflix did on these metrics. This letter to shareholders shows that revenue in Q1 came in at $7.16 billion which is a growth of 24% compared to Q1 2020. How does that look? 

Their operating margin came in at 27.4%, highest as it has ever been. Netflix management has long maintained that they want this number to be close to 25% long-term (higher the better). Their Earnings Per Share came in $3.75, once again, highest as it has ever been, more than double the $1.57 that Netflix earner in Q1 20. How does that look? 

I think what spooked the market is the guidance. Netflix is guiding for an addition of only 1 million subscribers in Q2 2021. However, if you only read the above letter, you will miss out on the context of why the management is guiding for only 1 million subscribers addition in Q2. 

For additional context, it is a good idea to read the transcript of the earnings call, which is available here. If you are new to investing, you might be confused about the difference between the letter to shareholders and the transcript of the earnings call. Every quarter, most public companies announce their earnings via a letter to shareholders and couple hours after that, the company’s management hosts an earnings call with financial analysts where they answer questions, sort of a follow up to the letter to shareholders.

This transcript goes in additional detail behind the context of their Q2 subscribers guide. Basically, the management believes that they saw a huge subscribers add in 2020 due to COVID and therefore they are expecting a small growth in the first half of 2021. Not only that, they could not produce as much original context that they wanted to in 2020 because of lockdowns in various parts of the world. Their subscriber growth is aligned to availability of new content and they expect as they release more context in the second half of 2021, they will see subscribers growth. 

If you are in Netflix for three months or so, then you have a reason to be disappointed. If you are in this for long-term (3-5 years), zoom out and think about this. They want to add about 25 million subscribers per year. They added 36.57 million subscribers in 2020. That leaves about 13-14 million subscribers to add in 2021 to exceed their goal. Q1 2021 had 4 million subscribers and they are guiding for 1 million subscribers in Q2. That will leave them about 9 million subscribers to add in Q3 and Q4 combined. Do you think that they can do that? If I was a betting man (and I am), I would bet that Netflix will be able to easily achieve or exceed that goal.

Not only that, I think the market has started to value Netflix differently. Earlier Netflix was being valued as a growth company with no P/E ratio because Netflix was incurring huge losses in its earlier years. Now, Netflix is maturing as a public company. They had a EPS of $3.75 in this quarter. Let’s average it out to four quarters (3.75 X 4 = $15) and Netflix will have a forward P/E ratio of about 33 ($500/$15). The management reiterated that they will be cash flow positive this year and will not need to borrow any money going further. On top of that, they are starting a share buyback program from this quarter and return excess cash to shareholders.

So, according to the title of this article, this is what I am doing right now with my Netflix holding. Nothing!

I have a decent-size holding in my portfolio and I will be looking to add during next six months. I want to be clear, this 10% decline is a buying opportunity and it can get worse before it gets better. So, while I do think that this is a good time to add to it, I won’t add all at once. I will buy in steps. For example, if I want to add $3,000 to my Netflix holding. I will buy $1,000 now and then a month later and then another month later and then wait for second half of the year to see if the management meets their targets.

I think I will be quite happy in 3 years that I bought after Q1 2021. I think that there is a transition happening in Netflix right in front of our eyes. Netflix is being turned into a value-play and maturing into a profitable growth company. I plan to hold my Netflix stock until it becomes a dividend aristocrat. 

Do you agree with me? Or do you think that this was a bad quarter and we should sell this and look for other stocks? Let me know by commenting below.