Job Growth Disappoints; Netflix Fires on All Cylinders


Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

The Department of Labor's "off-schedule" (due to the government shutdown) September employment report, released this morning, showed the economy added just 148,000 jobs last month, well below the 180,000 economists were expecting in a Reuters poll. Despite that, stocks are pushing on to new highs, with the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average up 0.79% each as of 10:25 a.m. EDT. Why? It is likely that the stock market believes, justifiably, that such weak gains forestall the Fed's "taper" of its bond-buying program.

If employment growth is tepid, some parts of the economy are firing on all cylinders. After gaining 6.4% yesterday in the run-up to its third-quarter earnings report, Netflix's stock is up another 2% this morning. Today's gains add to a meteoric rise in the share price: As of yesterday's close, Netflix was already the second-best-performing large-cap stock in the Nasdaq Composite Index (behind Tesla Motors) this year, having more than quadrupled.

The streaming film and TV company's third-quarter results were rock-solid, matching Wall Street's expectations for $1.1 billion in revenue and beating analysts' $0.49 earnings-per-share estimate by $0.03. Those figures represent 22% year-on-year revenue growth and a quadrupling in diluted earnings per share! The buzz concerning Netflix's original content, including Orange Is the New Black and House of Cards, helped push the number of U.S. subscribers past 31 million in the third quarter, surpassing HBO on that metric.

Netflix is still at a high-growth stage in its development, and investors are focused on that. Fair enough, but ramping up profitability will be critical in order to monetize that growth and justify the current share valuation. That balancing act is present in the company's global profitability goal -- which it reaffirmed in its first-class earnings letter -- to "stay profitable despite international investments."

How will it achieve that? Importantly, Netflix is on target to hit its goal for a year-on-year increase in its contribution profit margin of 4 percentage points in the fourth quarter, despite amortizing its investment in original content more quickly to match user viewing patterns. (The amortization is a cost that reduces earnings -- an accelerated amortization schedule means the cost is front-loaded compared to a straight-line amortization schedule.) The company's new guidance for contribution profit margin in the fourth quarter is 23.2% (contribution profits equal revenues minus the cost of revenues and marketing costs).

No question about it, Netflix' business is performing. If there is one concern, it's that the stock may reflect that -- and more. CEO Reed Hastings struck a cautionary note on that front, warning investors with a historical parallel:

In calendar year 2003 we were the highest performing stock on Nasdaq. We had solid results compounded by momentum-investor-fueled euphoria. Some of the euphoria today feels like 2003.

It's unusual for a CEO to comment on his stock price, particularly to temper expectations. Hastings is a straight shooter, and his words suggest long-term owners ought to be prepared for a volatile ride. However, investors can remain confident he will remain focused on methodically building an outstanding consumer franchise.

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Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on Twitter @longrunreturns. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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