Surge in NFLX Stock Proves Profit Growth Helps

Netflix (NFLX) handily beat fourth-quarter earnings expectations this week, with sales and subscriber numbers reaching new highs. But the profit growth—up 55% from the fourth quarter a year ago to $0.15 per share—is what really stood out, and it’s the biggest reason NFLX stock gapped up 7.5% on Wednesday, and another 6% on Thursday.

This marked the third straight quarter of double-digit earnings growth for Netflix, an impressive bottom-line course correction after the company failed to grow profits in the prior five quarters. Since the internet video giant returned to profit growth, when it reported second-quarter earnings on July 18, NFLX stock is up more than 42%, more than four times the 10.2% run-up in the Nasdaq over the same span.

NFLX Stock Getting a Big Boost from Earnings

The gap-ups after the last two earnings results were announced were especially pronounced. After EPS grew 71% in the third quarter, NFLX stock jumped 28% in the ensuing four trading days. Add in the 13% jump (so far) after this week’s earnings report, and NFLX stock has gained more than 40% in just six trading sessions—all after impressive earnings reports—since October (see chart below).

NFLX stock has risen more than 42% in the last six months.

Now, in fairness, NFLX went the other direction in July after reporting a 50% improvement in EPS; the stock plummeted from 98 to 85 in just one trading session. But the totality of NFLX’s performance since its earnings turned positive stands in direct contrast to how the stock performed in the year prior to its six-month rally. From July 2015 to July 2016, when Netflix churned out four straight quarters of either flat or declining profits, NFLX stock tumbled from 115 to 98—a loss of nearly 15%.

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There were other positive catalysts behind NFLX’s rally over the last six months: subscriber and sales growth, more quality, award-winning original programming like Stranger Things and The Crown, and an improved stock market climate since the Brexit vote in late June. But the contrast between last six months (+42%) and the year that preceded it (-15%) is pretty stark, and the fact that the last six months have coincided with a return to earnings growth is a major factor.

NFLX Winning on Substance

Companies don’t need to be profitable for their stock prices to rise—at least not in the early stages, or what my boss, Tim Lutts, calls the “Romance” phase. But eventually, the shine of a new stock fades, products become stale (see Apple (AAPL) of late), and investors want to see signs of growth, not stagnation.

Amazon.com (AMZN) shares were down considerably in 2014, a year in which the e-commerce giant failed to turn a profit. But in 2015, Amazon reported its highest earnings per share since 2011, and its stock more than doubled in a down year for the market.

Conversely, Facebook (FB) famously struggled in its first year after going public, in part because the company barely eked out a profit that year. Since then, the company has figured out how to make money hand over foot, and FB stock has risen five-fold.

Flashy products and groundbreaking innovations can get a company a long way on Wall Street. But that wow factor can only get you so far. Eventually, investors want to see substance, and profit growth helps in that regard.

Chris Preston

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Investment analyst and Chief Analyst of Cabot Wealth Daily, Chris Preston brings you all the latest from the investing world. Sign up to get updates and breaking news delivered FREE to your inbox. Get unlimited access to our library of complimentary investing reports.

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