Image shown: Netflix continues to experience robust growth and improvements in its operating margin, but free cash flow remains weak. Image source: Netflix’s second-quarter earnings shareholder letter.

By Brian Nelson, CFA

We’re okay with watching Netflix (NFLX) from the sidelines. The company has been lumped in with other companies such as Facebook (FB), Apple (AAPL), and Alphabet (GOOG) (GOOGL) as a "FANG" stock, but the economics of Netflix’s business is quite different than this "peer" group, while the competition is considerably more intense. During the past 52 weeks, shares of Netflix are roughly flat compared to a market that is up over 30%, as measured by the SPDR S&P 500 Trust ETF (SPY).

While Facebook, Apple and Alphabet continue to generate gobs of free cash flow, Netflix’s free cash flow profile remains weak. The company burned through $175 million in free cash flow during the second quarter of 2021, and free cash flow is expected to be breakeven on the year. With competition intensifying from the likes of Disney (DIS) and others, we don’t think Netflix can afford to shut off the expense gushers either--and that means trouble for the economics of its business model in the longer run.

Netflix’s second quarter, results released July 20, weren’t that bad, per se, as revenue advanced 19% on a year-over-year basis, while operating income surged to $1.8 billion, but it’s free cash flow that we care most about; the company is just not delivering in this area. Weak free cash flow performance means that earnings quality is poor, and we think other streaming providers are itching to eat Netflix’s lunch. Netflix’s expansion into gaming may be a sign that tougher times are ahead with respect to subscriber retention and content generation.

Without a doubt, Netflix has been one of the best-performing stocks the past decade, but we have a hard time making the case for the firm, especially in light of the much better balance sheets, competitive profiles and free cash flow generation at Facebook, Apple, and Alphabet. Our fair value estimate for Netflix stands just shy of $500, and we think the company’s shares will be rangebound until the next catalyst, which we think will be a negative one, given heightened competition. We remain on the sidelines.

Netflix's 16-page Stock Report >>

Tickerized for NFLX, GOOG, GOOGL, AMZN, DIS, T, DISCA, ROKU

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Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, and IWM. Brian Nelson's household owns shares in HON, DIS, HAS. Valuentum owns shares in VOO, SCHG, DIA, and QQQ. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.