The Real Engine Driving Netflix Stock Is Its Earnings Power

With the stock out of favor, investors are focused on slowing sales growth, but they may be missing the more powerful story of how efficiently Netflix is compounding profit per share.

If you've looked at Netflix (NFLX) stock recently, you've probably seen the damage. The shares are down 42% over the last year, and the narrative is dominated by fears of slowing growth, intense competition, and wavering user engagement. It's a story of a maturing giant whose best days are behind it.

But beneath the gloomy headlines, a different story is unfolding, driven by one under-appreciated number. It's the gap between the company's sales growth and its earnings-per-share growth.

Over the past three years, Netflix's revenue has compounded at 13.7% annually. Its earnings per share, however, have compounded at 50% per year.

How Profit Is Outrunning Sales

That isn't a typo or an accounting trick; it's the result of financial factors working behind the scenes. Two forces are driving this performance: the primary engine is a significant expansion in profitability, supplemented by a steady, disciplined reduction in the share count. While margin expansion has been the larger contributor to earnings growth, the 5.2% reduction in shares outstanding over the past three years ensures that every dollar of that increased profit is distributed across a smaller base, compounding the benefit for shareholders.

Netflix's operating margin has climbed consistently over the last three years-rising from 16.8% to 22.5%, then to 27.7%, and reaching approximately 29.7% over the last twelve months. While the pace of year-over-year margin expansion has naturally moderated as the company scales toward higher efficiency levels, the trend remains resolutely upward. Each dollar of revenue is now generating significantly more bottom-line profit, and by returning cash to shareholders, the company is ensuring that profit is divided among fewer slices, amplifying the return for each remaining share.

The Answer To The Growth Question

This is why the market's focus on top-line growth may be misplaced. The primary risk priced into the stock is that Netflix can no longer deliver the high sales growth of its past. But earnings-per-share growth means it doesn't have to. This structure allows for earnings-per-share growth through disciplined execution, even with more moderate revenue gains. For investors, a key question is how this earnings growth relates to the company's valuation.

The current valuation appears to give little credit for this reality. With a trailing price-to-earnings multiple of 23.3, the stock is trading toward the low end of its own 10-year history, which has seen multiples range from 15.3 to 285.0. This suggests the market is focused on the risks while overlooking the factors driving earnings growth for the business itself.

For anyone looking at Netflix, subscriber numbers tell only part of the story. The more crucial thing to watch is whether the operating margin is maintained or increased, as this has been a key factor in the company's earnings.

And if it is exposure to communication services as a whole you want rather than this one name, a communication services ETF like XLC covers that single sector.

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