An analysis of Netflix's (NFLX) free cash flow suggests the company's stock could be undervalued by nearly 15%. This valuation is contingent on the streaming giant maintaining strong financial performance, particularly a free cash flow margin of at least 20%, in its upcoming third-quarter results.
As of October 10, Netflix stock closed at $1,220.08 per share. A detailed projection based on expected revenue and cash generation indicates a potential price target of approximately $1,400 per share, signaling a significant upside for the company.
Key Takeaways
- A valuation model based on free cash flow (FCF) projects a potential price target of $1,400 for Netflix stock, representing a 14.7% upside.
- The analysis assumes Netflix can sustain a strong FCF margin of around 20.4% over the next twelve months.
- Analysts' forecasts show expectations for continued revenue growth, with projections reaching $45.05 billion in 2025 and $50.87 billion in 2026.
- The current market capitalization of $518.4 billion may not fully account for the company's robust cash generation capabilities.
Analyzing Netflix's Revenue and Growth Outlook
Netflix has demonstrated consistent revenue growth, a trend that analysts expect to continue. In the second quarter, the company reported a 15.9% year-over-year revenue increase, reaching $11.079 billion. Management has guided for even stronger growth in the third quarter, forecasting a 17.3% rise to $11.526 billion.
This positive outlook is supported by a consensus among financial analysts. According to data from Seeking Alpha, the average revenue forecast from 44 analysts for the full year 2025 stands at $45.05 billion. Projections for 2026 are even higher, with an average forecast of $50.87 billion, which would represent an 11.8% increase over 2025.
These figures indicate that the market anticipates sustained strength in Netflix's subscription and advertising revenue streams, forming a solid foundation for its financial performance.
Recent Stock Performance
Netflix stock has shown volatility in recent months. After reaching a peak of $1,263.25 on September 9, it saw a decline to a low of $1,143.22 on October 3. The stock's closing price of $1,220.08 on October 10 places it between these recent highs and lows, suggesting the market is awaiting further catalysts, such as the upcoming Q3 earnings report.
The Importance of Free Cash Flow Margin
A critical metric for valuing Netflix is its free cash flow (FCF) and, more specifically, its FCF margin. This margin represents the percentage of revenue that the company converts into cash after accounting for operating expenses and capital expenditures.
Netflix has recently produced strong FCF margins. In the first quarter of the year, its FCF margin was 25.2%. This was followed by a 20.5% margin in the second quarter. The average for the first half of the year was a healthy 22.85%.
Over the last twelve months, the company's FCF margin has been 20.39%, according to Stock Analysis. For valuation purposes, a conservative estimate of 20.4% for the next twelve months (NTM) is used to project future cash generation.
Projecting Future Cash Flow
To estimate Netflix's FCF over the next year, we can use a weighted average of analyst revenue forecasts. This approach gives more weight to the 2026 forecast, as the market tends to be forward-looking.
The calculation is as follows:
- 2025 Revenue Contribution: 25% of $45.05 billion = $11.26 billion
- 2026 Revenue Contribution: 75% of $50.87 billion = $38.15 billion
- Total NTM Revenue Projection: $11.26 billion + $38.15 billion = $49.41 billion
Applying the assumed 20.4% FCF margin to this projected revenue gives an estimated NTM free cash flow of $10.08 billion. This figure is 17.6% higher than the $8.5 billion in FCF generated over the trailing twelve months (TTM) as of Q2.
Valuation and Price Target Calculation
One method to determine a stock's intrinsic value is to use its FCF yield. This metric shows how much cash the company generates relative to its market capitalization. As of Q2, Netflix's run-rate FCF of $9.068 billion against its market cap of $518.44 billion gives an FCF yield of approximately 1.75%.
Using the TTM FCF of $8.5 billion results in a yield of 1.64%. The average of these two figures is a 1.695% FCF yield. This implies the market values Netflix at a multiple of roughly 59 times its FCF (1 divided by 0.01695).
Deriving the Market Value
By applying this 59x multiple to the projected NTM FCF of $10.08 billion, we can forecast a potential market capitalization for Netflix:
$10.08 billion (NTM FCF) x 59 = $594.72 billion (Forecasted Market Cap)
This projected market cap of nearly $595 billion is 14.7% higher than the company's current market cap of $518.4 billion. Applying this same percentage increase to the current stock price gives a target price of approximately $1,400 per share ($1,220.08 x 1.147).
"This analysis suggests that if Netflix continues its strong free cash flow generation, the stock holds a potential upside of nearly 15% from its current levels."
Analyst Consensus Aligns with Undervaluation Thesis
This price target is not an outlier. The broader analyst community also appears to view Netflix stock as undervalued, though with slightly more conservative targets. A survey of 47 analysts reported by Yahoo! Finance shows an average price target of $1,358.61. Similarly, Barchart's survey indicates an average target of $1,388.55.
The average of these analyst targets suggests a potential upside of 12.6%. When combined with the FCF-based target of 14.7%, the consensus points to a valuation gap of around 13.65%, reinforcing the idea that the stock may have room to grow.
An Options Strategy to Consider
For investors who believe in this upside potential, an options strategy can offer a way to gain exposure with potentially less capital outlay than buying shares directly. One such approach involves a combination of selling puts and buying calls.
This strategy aims to generate income while positioning for a potential increase in the stock price.
- Selling Out-of-the-Money (OTM) Puts: An investor could sell a put option with a strike price below the current market price. For example, selling the $1,150 put option expiring in one month could generate a premium. This strategy produces income, and if the stock price falls below $1,150 at expiration, the investor would buy the shares at a discount to the current price.
- Buying In-the-Money (ITM) Calls: To capture the potential upside, an investor could buy a longer-dated call option. For example, buying a $1,160 call expiring in six months provides the right to buy Netflix shares at $1,160. If the stock rises to the $1,400 target, this call option would become highly profitable.
The income generated from repeatedly selling short-term puts could potentially offset the cost of the long-term call option, creating a strategy with a defined risk-reward profile. However, options trading involves significant risks and is not suitable for all investors.
