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Two Important Lessons from the NFLX Earnings Sell-Off

Investors panicked after this week’s NFLX earnings report, selling the stock off in droves. A closer look reveals that the panic was needless.

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It’s second-quarter earnings season in the stock market, and that means investors are going to witness some interesting price action as traders make rapid decisions to buy or sell within minutes of corporate earnings releases. Some of their decisions will be unwise, and since they operate like a flock of birds, rapidly launching in the same direction, those unwise decisions are going to create investment opportunities for thoughtful investors.

We saw that type of exaggerated price action this past Tuesday, when Netflix (NFLX) began trading after reporting second-quarter results. Much of the earnings report was fantastic. But the first news headline focused on the one disappointing number from the NFLX earnings report – subscriber growth – and the next 20 headlines waved that number as if it were the white flag of battle, cuing day traders to sell! Sell! SELL!

Lesson #1: Ignore the Headlines

The first important lesson here for investors is about the media. During earnings season, the media will scan earnings press releases for a number that appears alarming, and they will put that number in their headlines. It actually won’t matter whether that number bears any relation to the overall success of a company’s quarterly results and future business projections. It’s the media’s job to get you to pay attention to them, and they can’t attract your attention by saying “Netflix Reports a Strong Earnings Beat” while all their peers are saying “Netflix Subscriber Growth Misses the Mark” and “Is the Netflix Business Model No Longer Working?”

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Sensational news headlines are a bit like a broken-down car along the highway. You don’t stare at all of the well-working cars that surround you. Instead, you stare at the broken car, hoping to get a glimpse of some sort of chaos.

As a result of the unflattering news headlines, NFLX fell as much as 14.1% below the prior day’s close when the stock began trading on July 17, falling from $400.48 to a low of $344. Whoa!

Lesson #2: Read the Earnings Report!

What happened next is your second important investment lesson. After traders drove the stock down, the folks who actually read the earnings report realized that Netflix is thriving. They stepped in and bought shares, driving the stock back up to $379.48, which is higher than where it had opened that morning.

The lesson? Read the earnings report. Virtually all companies issue press releases that contain the pertinent balance sheet numbers, plus significant comments from the CEO. Why read a journalist’s two-paragraph interpretation of the press release when you can read the original document?

Here’s what the traders missed. NFLX earnings per share (EPS) in the second quarter came in at $0.85 vs. the consensus estimate of $0.79. That’s a big upside earnings surprise!

Revenue came in on target with estimates at $3.9 billion. What’s more, revenue is expected to grow from $11.7 billion in 2017 to $15.9 billion in 2018 to $19.8 billion in 2019. As you can tell, Netflix continues to offer popular and well-received internet TV services.

Netflix missed subscriber growth expectations by approximately one million, reporting 5.2 million new subscribers when the market expected 6.2 million. Basically, the company mis-forecasted the quarter’s new subscribers. If you look at the last four quarters combined, Netflix subscriber growth surpassed targets by three million, and surpassed the prior year’s total by five million. So relax. The Netflix audience continues to grow, all around the world.

The growth rate of revenue per paid subscriber has also increased consistently in recent years, up 2% in 2013, rising to an 11% increase in 2017 and on track for at least another 11% increase in 2018. Those figures help investors understand the source of the company’s strong profit growth. Netflix has a rapidly-growing subscriber base, with each subscriber spending more money on Netflix services than they did in the prior year.

NFLX Earnings Forecast Strong

As a result, Wall Street expects full-year EPS to grow 116% and 62% in 2018 and 2019. Those are huge numbers! For comparison, PepsiCo’s (PEP) profits are projected to grow 9% and 6.5% in 2018 and 2019; and Wal-Mart’s (WMT) profits are projected to grow 9.3% and 3.5% in 2018 and 2019.

You can see that Netflix offers investors much bigger profit growth than most famous companies. That’s going to continue drawing investors to NFLX shares, and the buying activity is going to continue pushing the share price upward. It will likely be many years before Netflix’ profit growth slows to a single-digit pace like PepsiCo and Wal-Mart.

Investors can be assured that Netflix is still a thriving company and an aggressive growth stock. The share price happens to be on sale right now. Institutional investors quickly recognized that bargain halfway through the trading day after the share price fell. It’s not too late for savvy investors to buy NFLX stock at a recent low price and profit from the company’s continued rapid international growth.

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Crista Huff is the lead analyst of Cabot Undervalued Stocks Advisor, where she combines a strict fundamental methodology with technical analysis, to identify growth and value stocks whose charts are turning bullish.