Netflix inventory overwhelmed up: Why shares are down 6% after earnings

Netflix (NFLX) shares fell roughly 6% in after-hours trade Tuesday after the streaming giant’s Q3 earnings revealed healthy topline growth but a notable step back in profitability — with investors noting margin compression.

• Revenue: $11.51B vs $11.51B expected
• EPS: $5.87 vs $6.97 expected

Revenue rose 17% year-on-year to $11.51B, right in line with Netflix’s forecast, driven by steady membership gains, ad revenue momentum, a weaker US dollar and pricing adjustments. A drag was that operating income of $3.25B fell short of expectations, with margins compressing to 28.2% from 31.7% in the prior quarter and below the 31.5% guidance. The caveat is that there was a $619 million charge tied to a dispute with Brazilian tax authorities, which cut 5 percentage points from margins. Full-year operating margin guidance was trimmed to 29% from a prior 30% due to the same issue.

Happy Gilmore 2 and KPop Demon Hunters were hits in the quarter while the advertising business logged its best quarter ever in a sign of where things might be headed for viewers.

Free cash flow remained a highlight at $2.66B in Q3 — flat from Q2 and up from $2.19B a year ago. The company sees $9 billion in FCF against a market cap of $526 billion (pre drop), which is about a 1.7% FCF yield. The company is virtually debt free.

What investors are paying for is growth and the company guided for 17% revenue growth in Q4. What could be further hurting the stock though is that the company sees a 23.9% operating margin in Q4. That’s been reeled back in after a rise starting in 2024.

I assume that the combination of the collapse of Hollywood salaries and the use of generative AI will ultimately goose margins but the risk is that users (particularly young ones) tune out of Netflix and tune into YouTube and video games.

The company sees revenues at $44.8 billion to $45.2 billion and shares are trading at 11.6x that. Looking way, 2027 consensus revenue is $56 billion and EPS of $39.40 per share, which is still 29.5x earnings (after the 6% drop after hours).

In short, shares are rich and any signs of a slowdown in growth or profitability are a drag.