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Why investors are cool on Netflix
The video-streaming service is posting strong profits, but Wall Street remains unimpressed
 
Netflix's successful foray into original programming, including Orange is the New Black, has yet to impress investors.
Netflix's successful foray into original programming, including Orange is the New Black, has yet to impress investors. Facebook.com/Netflix

This week, Netflix announced net earnings of $29 million off $1.07 billion in revenue for the second quarter — the profit was a fivefold increase from the same period last year.

In addition, shares have almost tripled this year, making Netflix the number one performer on the S&P 500 Index.

But investors aren't exactly busting out the champagne over the latest quarterly report. Netflix's share price shrunk $16.12 in after-hours trading Monday, to $245.84, down from a 52-week high of $259.85. And though it rebounded some this morning, it's still down more than 2 percent from closing yesterday.

So what's the problem?

Part of it is growth. Netflix announced 630,000 new subscribers in the second quarter, smack dab in the middle of the company's expected range, and tangible evidence that its foray into original programming is paying off — but that was still lower than Wall Street's estimate of 700,000. The discrepancy, though hardly disastrous, points to the underlying challenge of Netflix's recent success: How to keep growing at a rate that justifies its hulking share price.

"The larger we get, the harder it is to grow," the company's CEO Reed Hastings said in his webcast Monday.

Online subscriber growth was offset by a 470,000 loss in DVD subscribers. Netflix finished the quarter with 28.6 million paid domestic subscribers — just a whisker shy of HBO's 28.8 million, but well behind Hastings' long term goal of 60 million to 90 million.

And Netflix's rivals in the video-streaming world might make growth even more challenging as time goes on. Netflix might have been one of the first horses out of the gate in the race for the future of TV, but Amazon and Hulu are at the track as well. "For now at least, Netflix has a leg up on the competition, but it needs to keep growing its subscriber base to maintain its advantage," says Sam Gustin at TIME.

On Monday's webcast, Hastings acknowledged concerns about HBO Go, Hulu, and Amazon Prime Instant Video, and said intense competition could drive up the price of content — which could increase Netflix’s costs and lower its profits.

What's more, Netflix's profits are not yet aligned with its share price. "By conventional metrics, Netflix's stock looks extremely expensive, with a ratio of price-to-estimated earnings over the next 12 months of 146, according to S&P Capitol IQ," says The Wall Street Journal.

Still, despite its challenges, the company has its defenders. "Reed Hastings and his team are trying to execute a strategic pivot from content licensing to content production that’s daring, difficult, and necessary," says Matthew Yglesias at Slate. "That they’re pulling it off while steadily growing their subscriber base is an enormous accomplishment."

 
Carmel Lobello is the business editor at TheWeek.com. Previously, she was an editor at DeathandTaxesMag.com.

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