Just a few years ago Netflix‘s (NFLX 1.14%) High content spend meant that free cash flow was consistently negative. Fast-forward a few years, and the company is measuring that cold, hard cash at billions of dollars. The streaming service specialist is at a tipping point when it comes to profitability — and that tipping point will likely become even more apparent in the future.
Generating positive free cash flow is probably music to shareholders’ ears. It’s been around 10 years since the company embarked on an aggressive strategy of investing in original content. A decade later, the once-risky strategy looks pretty awesome with hindsight.
The company’s content library now contains many must-see films and shows, some of which have global appeal. Better still, Netflix has now reached the necessary scale to profitably sustain its current production of high-quality content.
Here’s a close look at Netflix’s earnings despite continued aggressive content spending.
Free cash flow increases
Netflix management announced in its most recent fourth-quarter update that it generated a total of $1.6 billion in free cash flow in 2022. That level is above roughly break-even free cash flow in 2021 and negative $3.3 billion in 2019, making it clear that this is a turning point for the company. Remarkably, Netflix’s free cash flow was $1.9 billion in 2020, but that was due to many film studios pausing production as the world grappled with the rapid spread of COVID-19.
Looking ahead to 2023, management is forecasting record free cash flow of “at least $3 billion,” assuming there are no significant currency fluctuations.
To illustrate just how impressive this prospect is, it comes as the company plans to keep its monstrous annual content spending budget at around $17 billion. Additionally, Netflix is building a new advertising business that will require new employees, technology, and additional product development costs.
Stocks are valued for near perfection
While this turnaround in profitability is good news for Netflix shareholders, the stock’s rise over the past few months may already have discounted Wall Street’s rosy outlook for the company. Netflix’s market cap of $161 billion as of this writing is about 53 times the company’s projected free cash flow this year. Even with free cash flow growing to $4 billion in 2024, the stock currently trades at 40 times that expected free cash flow.
Fortunately, the launch of an ad-supported tier of Netflix helps mitigate some of the risks of owning the stock, giving the stock a premium rating. Management recently said it expects its advertising business to grow to more than 10% of revenue in the coming years, making it a big contributor to both top-line and bottom-line earnings. This new revenue stream gives Netflix a larger addressable market than it would have had it remained a subscription-only streaming service.
However, investors should keep in mind that the stock is already pricing in strong growth for years to come. While it’s good to see the company reaching an inflection point in profitability, it doesn’t necessarily make the stock a bargain at these levels.
Daniel Sparks has no position in any of the stocks mentioned. Its customers may own stocks of the named companies. The Motley Fool has positions in and recommends Netflix. The Motley Fool has a disclosure policy.