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Netflix Q3 Earnings: Lower Margins Amid High Valuation

TradingKeyOct 22, 2025 5:55 AM

Investment Thesis

TradingKey - In our last Netflix article in late April, we expressed our concern about the high valuation of the company. Since then, NFLX has underperformed the broad market index (11.54% vs 21.82%). We still believe the current valuation of above 50x PE is high, reflecting the upside potential from the ad business, but ignoring the risks related to boycotting and potential intensified competition.

Netflix

Source: TradingView

Earnings Overview

Netflix reported Q3 earnings on 21st of October, after the market. The stock price fell 6.5% as the company missed its EPS target with the significant amount of $1.09.

Netflix

The total revenue increased 17%, driven by a combination of an increase in subscribers, price hikes and ad revenue.

A significant contributor here is the blockbuster movie KPop Demon Hunters, which was watched nearly 325 million times, becoming the most-watched Netflix-produced movie. The movie itself also hit the theatres, further contributing to the revenue. Other major content that drove viewers include Wednesday Season 2, Happy Gilmore 2, and the Canelo vs. Crawford boxing match.

In terms of geographical revenue segments, we didn’t see surprises, as the main markets of North America and Europe grew +17.3% and +18.1%, respectively. The Latin American market grew relatively low (+10.5%) due to currency fluctuations, while APAC remained the highest growing geography (+21.3%).

The main issue for the Q3 earnings was the lower-than-expected margins. The company recorded a one-off $619 million tax settlement expense with the Brazilian authorities. The expense itself is recorded in the cost of revenue. Hadn’t the expense occurred, the EPS would be $7.30, comfortably beating the estimate of $6.96.

Free Cash Flow remained strong at $2.8 billion (versus $2.3 billion in 3Q2024), which was mainly used for share repurchases.

During the call, in response to the recent rumors, the management downplayed the possibility of acquiring Warner Bros. Discovery (WBD). This is a rather positive piece of news. Acquiring an asset-heavy, debt-ridden business like WBD would have negatively affected Netflix's financials and long-term operations.  

For Q4, the management projected 16.7% revenue growth, which is in line with what we saw in Q3. However, the operating margin for Q4 is expected to be around 23.9%, lower than what we saw in the past three quarters. This can be explained by a combination of factors. Firstly, the recent successful content has to be amortized, and this will suppress the gross profit. Secondly, more investment will be made in advertising infrastructure and gaming, supporting these two emerging revenue streams. Thirdly, we have the “seasonality factor”, Q4 has often been the time when Netflix spends more on marketing due to the holiday season.

Overall, the Q4 content pipeline is still strong, with titles like Stranger Things (final 5th season), The Diplomat and NFL Christmas Day Games expected to keep the viewers’ attention.

Netflix

Source: Netflix Letter to Shareholders

What to expect

If we zoom out from the recent earnings results and see the long-term picture, Netflix is at a crossroads, as it moves away from the pure subscription-based business model and focuses its efforts on developing a robust ad business.

The ad pivoting comes at the right time, and it will also bring several benefits. Firstly, it will diversify the revenue away from subscription. Secondly, ad revenue is expected to have a relatively high margin, and they do not need to spend extra on content, driving the company's margins. Lastly, the user base of 300 million viewers is already critically big, and the data from it will help Netflix develop a robust ad product comparable to those of Amazon, Meta and Google.

We do expect Netflix to utilize more AI in their business operations, not in the form of creating AI-generated content, but towards improving the recommendation algorithm. It is estimated that 80% of the viewing comes from recommendations, and improving the algorithm will have a significant positive impact. Ad revenue will also benefit from AI, as the ad targeting will be more precise and effective.  

Risks

The “Cancel Netflix” campaign

Luckily, Netflix is relatively immune to geopolitical tensions and trade wars; however, the recent “Cancel Netflix” campaign unviewed a certain vulnerability. Netflix content has often been criticized for being “woke”, taking a strong liberal stance on sensitive issues like race and gender identity, causing dissatisfaction from the more conservative viewers of the platform. “Cancel Netflix” was supported by some prominent figures on the right, including Elon Musk, and led to the stock price going down for several days in a row.  Netflix has to keep a very delicate balance, especially in the current, overly polarized political landscape. Failing to do so may cause subscribers’ churn or even the removal of content.

Competition

Overall, we can’t deny that Netflix is in a very comfortable competitive position with its content being a very strong moat, much better than direct competitors like Prime, Hulu and Disney. However, if we compare Netflix with YouTube, the picture is more complex. As of June 2025, we can see Netflix’s portion of US TV Time being rather stable at around 8%, while that of YouTube is not only bigger, but also growing with every quarter, reaching nearly 13%.

Netflix

Source: Nielsen, appeconomyinsights.com

Indeed, there is not much overlap in the content between the two giants – YouTube is all about user-generated content like vlogs, tutorials, music videos and shorts, while Netflix is about movies, series and live events. But they both fight for the viewers’ attention and ad dollars. This competitive dynamic may actually imply that YouTube, not Netflix, is the platform that will mainly entertain the audience in the future.

Sports and other live events will continue to be a battleground for the streaming players. Recently, Apple won the right to broadcast F1, making the whole fight for winning and broadcasting live sports events quite intense. The risk for Netflix is whether they will keep a prudent investment approach in content; otherwise, they can overspend on events with questionable ROI, which will harm the profitability of the firm.

Regulatory risks

The one-off expense $619 million from the Brazilian tax authorities is a good example of how unpredictable regulatory hurdles can negatively impact the business. As Netflix is a global platform, it will remain prone to such events. Moreover, with the growing ad business, the chance of Netflix facing data privacy issues also increases.

Projections and Valuation

Ad revenue will grow quite fast in the coming three years, but it is still from a very small base; thus, we do not expect ad revenue to be more than 15% of the total revenue in 2027. However, the higher-margin nature of the ad business will drive the earnings growth higher than the top-line growth of 15-16%, expecting EPS to grow at around 18-20% in the coming years.

This growth of 18-20%, while looking attractive, may not fully justify the high valuation of over 50x PE, and this explains why the stock has not moved much.

Stock Score(EN)

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TradingKey Stock Score
Netflix Inc Key Insights:The company's fundamentals are relatively very healthy. Its valuation is considered fairly valued,and institutional recognition is very high. Over the past 30 days, multiple analysts have rated the company as a Buy. Despite an average stock market performance, the company shows strong fundamentals and technicals. The stock price is trading sideways between the support and resistance levels, making it suitable for range-bound swing trading. View Details >>
Reviewed byHuanyao Fang
Disclaimer: The content of this article solely represents the author's personal opinions and does not reflect the official stance of Tradingkey. It should not be considered as investment advice. The article is intended for reference purposes only, and readers should not base any investment decisions solely on its content. Tradingkey bears no responsibility for any trading outcomes resulting from reliance on this article. Furthermore, Tradingkey cannot guarantee the accuracy of the article's content. Before making any investment decisions, it is advisable to consult an independent financial advisor to fully understand the associated risks.

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