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What's Causing Netflix Stock (NFLX) to Slide Down 13%?

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We grew by 1.7m members in Q2 finishing with over 83 million members. This is below our forecast of 2.5m net new members and our prior year Q2 net additions of 3.3m. We are growing, but not as fast as we would like or have been. Disrupting a big market can be bumpy, but the opportunity ahead is as big as ever and we continue to improve every aspect of our business.

That was the opening paragraph of the premier streaming television company’s Q2 2016 letter to the shareholders. As of 12:10 PM ET, Netflix stock (NFLX - Free Report) was down 13.59%, with the missed global new member forecast figure being the primary culprit of this bad trading day. Netflix did, however, beat our earnings estimate figure with a surprise percentage of 350%, as well as saw 28% year-over-year revenue growth. Yet, that was not enough to overcome the poor subscriber performance.

There are two questions that need to be addressed in light of Netflix’s second quarter results: what caused the company to miss its members’ forecast and should member growth be the most important metric to determine “success” for the company?

The Forecast

Regarding the first question, it is quite difficult to pinpoint the “smoking gun” reason to why Netflix did not have the global subscriber growth it expected. It is no way the cost of the service. Netflix has three different packages with the most popular “Standard” one being $9.99 per month. As someone who has had a Netflix account for almost five years now, and used to spending $7.99 per month on the “Standard” package, if Netflix were to raise the price again by another $2, I would not be upset. The quality of the Netflix Originals and the diverse library keeps me hooked in.

Speaking of the Netflix Originals, the content may very well be the cause. As written in the letter to the shareholders, Netflix “continued to expand the pace and breadth of original series, films and documentaries released on Netflix, including the 4th season of Orange is the New Black and the second of our Adam Sandler films, The Do Over, which, at launch, was the number one most­ watched film on Netflix in every territory of the world and remains in the top 10 in many countries, including the US.”

Netflix is also developing more non­-English language original series and films in more than a dozen countries including Brazil, Germany, India, Italy, Japan, Mexico, Colombia, South Korea, Argentina and Spain. The only semi-non-English speaking original series the company has is Narcos, which was somewhat popular when it was released. However, it did not garner the same mainstream popularity as House of Cards did when its inaugural season debuted.

Despite 17 of its original series, documentaries, films and comedy specials receiving 54 Primetime Emmy nominations, seeing the largest increase in nominations among networks (up from 34 last year), and having the third most total nominations of any domestic network (behind only FX and HBO), Netflix has not had “the series” of 2016 to capture the mainstream’s attention.

The 4th seasons of House of Cards and Orange is the New Black are not going to bring in more new members. Adam Sandler films are not going to bring in more new members. I’m currently watching a new Netflix Original Series called Stranger Things, and I am enjoying it quite a bit. However, a series that is an homage to late-70s and early-to-mid-80s science fiction, horror, and fantasy films is not going to bring in more new members.

Netflix does not have its Game of Thrones type series that reaches a vast audience and has a collection of niche series that target small groups. They should look to find that balance between mainstream and niche in order to continue to bring in new members.

The Key Measuring Metric

As previously stated, shares of NFLX are down due to the company missing its global subscriber forecast and quite frankly, that’s simply not a good reason to sell of Netflix stock. Keep in mind that despite not currently having the “go-to” show of 2016, the company still brought in 1.7 million new members, which is a year-over-year total membership growth figure of 26.9%. Again, Netflix beat our earnings estimate figure with a surprise percentage of 350% and saw 28% year-over-year revenue growth. These metrics would suggest that Netflix is doing quite fine.

At some point, the new global member figure cannot be the “end-all, be-all” metric to determine how successful Netflix is for the quarter. In the next few years, the new subscriber total will begin to plateau as more and more people will have a Netflix account. The results of this quarter may be the beginnings of this plateau – it’s far too early to tell, though. Once the point is reached where a large number of people across the globe have Netflix, is the company no longer successful because it doesn’t bring in enough new members? Of course not. That would be ridiculous.

Netflix is reaching the point where issues pertaining to its content and key earnings figures like EPS and revenue should be more important that new member totals. If Netflix has a quarter where the company actually loses members, then that warrants serious concern. Missing the forecast by 800,000 and still beating earnings and had year-over-year revenue growth? That’s a good thing, not something to cause a stock price drop of over 13%.

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