Background:

Netflix (NFLX), the online streaming site that everyone around the world has come to know, biggest strength lies in its established user-friendly brand name and its large library content. Although their margins sunk during Q1 2016 to 1.41% from 2.37% during Q4 2015; this was largely due to their expansion expense of about $4.1 billion, while revenue barely grew. However, Q2 showed the beginning of a turnaround for Netflix, as they saw an increase in both their top and bottom line.

Positive View of Fundamentals:

They had posted EPS at $0.09, beating analysts Consensus by seven cents. They had also seen large increase in revenues of 28%, to $2.1 billion. Together this translate into an increase in their net margins to 1.94%, and a net income of $40.78 million.

Below is Netflix’s Net Margin:

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Although this is way below the industry average, that is somewhere between 10%-20%, the increase in their net margins shows improvement in their profitability as well as positive results from their global expansion. This as a result, shows a change in the negative margin trend.

They thus have a large amount of room to grow, in order to please investors. They have many routes in order to increase those margins.

Although they can simply focus on a wealthier target niche, and charge a higher premium; this would be overly short-sighted, as they are set to be finishing their global expansion and main technological improvement this year, mainly with their video distribution framework cost. Furthermore, they have already had a price hike of $2.00, subscription plan, which had hurt their grandfathered and more rural subscribers.

Therefore, a smarter more long-term strategy is to continue their operations as they are.

Market Growth Development:

The reason being is due to a possible growth in both the domestic (US) and international markets.

Although many investors believe that the market is mainly saturated in the US, they overlook a crucial fact about the younger generation and millennials still living at home. This is as well explained by the increased bullish outlook of NFLX by William Blair. There millions of young Netflix users, who do not pay for their account usage, i.e. under their parents account. Therefore, by 2020 is set to be able to achieve their domestic viewer increase by millions of viewers, about 5.3 million as explained, taking 3% (conservative estimate) of the set 70 million millennials who are estimated to be in the target audience.

The further increase of more original content development as well brings on more long-term value creation. Since they can increase their margins past licensing agreements to more cost efficient self-development of original content. In the short term, they will, however, having a higher cash burn rate, which was seen in Q1 2016, as well as partly in Q2 2016.

For an investor seeking value investment, this is a critical factor that cannot be overlooked, because historically the value of revenue growth from the young is often overlooked.

In addition to domestic growth, there is a much more current growth expected from the international market. This year alone, Netflix expects their subscriber audience to grow by 38% from the international sphere, as well as about 2.8 million of those coming from new markets launched in 2016. Although their revenue does not match their costs of around 42% in 2016, as described by analysts, those costs are expected to be stable or even diminish as they expect the completion of their expansion costs. Thus Revenue will be able to increase the margins, to a more positive light. Revenues by 2020, globally are expected to reach $13 billion, with a larger portion coming from abroad. Both the growth of the domestic market and international market, as well as finishing of development will allow for Netflix to begin having positive free cash flows.

Although NFLX shares are priced on the expensive side, with forwarding P/E at 330, if they will be able to continue expanding their profit margins this can be highly reduced, and even cut in half if they reach the profit margins of the industry range.

Conclusion:

The charge for Netflix now is to maintain (or hopefully reduce) cost level, while continue to reap their revenue growth from abroad. They can, in fact, achieve this through their new technological efforts, continual expansion of more original content, shown to have higher approval ratings than regular licensed movies/shows, and new content tailored to local markets. The competition domestically mainly revolves Amazon and their own Prime Video service, as well as HBO. While abroad include numerous other rivals similar to Amazon, such as Canada’s Shomi and Southeast Asia’s iflix.

Most importantly, for both value and fundamental investors, real revenue growth (above expenses), is known to be one the most important factor to appropriately value a firm and be able to justify reasoning for a firm to be considered a "great investment" in long- term.

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Netflix (NFLX) is up more than 14% since June 28, showing correct predictability of the last bullish article written by an I Know First analyst. Currently, the Algorithm maintains a bullish stance on NFLX, as described below.