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What You Might Have Missed When Netflix, Inc. (NFLX) Reported Earnings

When Netflix, Inc. (NASDAQ:NFLX) reported earnings on Monday night, investors expected big things. Share prices had soared 193% year to date when the report dropped in, but fell 5% on the news. Investors and analysts focused on 0.6 million new domestic subscribers during the quarter, worrying that it was too low a number.

That’s the only number you’ve seen in most Netflix, Inc. (NASDAQ:NFLX) headlines this week, but there’s much more to the story. Let’s take a look at three important takeaways you may have missed.

Guidance? We don’t need no stinkin’ guidance!

Some analysts were hankering for more than 1 million new subscribers from the long-awaited extension of Arrested Development alone. Against that backdrop, 630,000 new American subscribers looks like a big miss. You can read it as Netflix, Inc. (NASDAQ:NFLX) losing subscribers this quarter if you back out the banana stand!

But then you’re ignoring the company’s own guidance for the quarter. Netflix set the guidance range for the second quarter between 230,000 and 880,000 net additions. 630,000 falls in the upper half of that range, which was set with Arrested‘s debut in mind.

Moreover, you might recall last year’s second-quarter report. That time, Netflix, Inc. (NASDAQ:NFLX) shares plunged 25% overnight as seasonal effects held back subscriber additions over the summer. May I remind you how share prices nearly tripled over the next six months, when the fun and profitable half of the yearly growth cycle played out? The same seasonal effects are still in place, holding Netflix back in the summer with a commensurate boost around the holidays.

So the performance didn’t blow guidance out of the water, but certainly shouldn’t count as a big miss, either. And as a Netflix, Inc. (NASDAQ:NFLX) shareholder, I’m certainly looking forward to the third and fourth quarters this year.

The HBO limit doesn’t apply to Netflix

Skeptics often scoff at Netflix’s goal to become two or three times the size of Time Warner Inc (NYSE:TWX)‘s premium cable channel HBO. That channel has been bumping against a glass ceiling for years, never breaking through the 30 million subscriber threshold. If a well-established consumer brand with the money and marketing might of Warner behind it can’t move beyond this limit, why should we accept 60 million or 90 million as a destination for Netflix?

Well, Netflix is about to cross that illusory threshold. The low end of third-quarter guidance points to 30.4 million American subscribers. Pop goes the glass ceiling, unless you expect management to set unreachable short-term targets.

Don’t forget that you’re looking at a virtuous cycle. Once Netflix collects enough revenue to cover its content costs, every additional streaming member is almost 100% pure profit. The streaming delivery costs are minuscule.

What does this mean for the long-term growth trend? Here’s how CEO Reed Hastings put it on the earnings call:

What happens is by the time we get to 40 million and 50 million, we get the content better and the service better. And so it’s not 60 million or 90 million for the current service. It’s 60 million or 90 million for the future service that’s much improved with maybe a lot more originals and just incredible streaming.

In other words, as Netflix makes more money from higher customer counts, the company will invest this cash in stronger content and better technology. And as long as you’re building a better service, why wouldn’t you expect subscribers to keep signing up?

Recommendations matter. A lot.

Here’s one that caught me by surprise: More than 75% of the viewing hours on Netflix start with the recommendations system.

Room for improvement: My family has varied tastes. Image source: Author’s screenshot of current recommendations.

That’s a huge number, and it underscores the competitive advantage Netflix built over the last decade or so. In short, Netflix is pretty good at figuring out what you want to see. The company wants to become the ultimate cure for channel surfing, because that would mean gluing your eyeballs to the Netflix screen in a way that traditional TV channels just can’t match. No, not even HBO.

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