Netflix (NASDAQ:NFLX) The Q2 Red Flag Hidden Behind 13% Revenue Growth

Content Spend Jumps 28%, But Engagement Barely Moves

There was one core thesis that we think many investors overlooked in Netflix’s second-quarter results.

Much of the market’s attention centred on revenue, which grew 13% year over year to US$12.56 billion. While still an impressive result, it also continued the gradual moderation in Netflix’s top-line growth. At the same time, sentiment had been weighed down by the loss of the Warner Bros. Discovery content agreement, with many viewing it as a headwind for subscriber engagement.

We think the more important story lies elsewhere: Netflix’s content economics are beginning to show signs of deterioration.

During the quarter, Netflix invested US$4.93 billion into new content assets, an increase of 28% year over year, signalling that the company is spending significantly more to sustain future growth. On its own, that isn’t necessarily a concern. The issue emerges when this investment is compared with the return it is generating.

Content amortisation, which reflects how quickly Netflix’s existing content library loses economic value as titles are consumed and become less relevant, increased 11% during the quarter. Yet, despite this much higher investment and faster depreciation of its content library, viewing hours increased by just 2%.

In other words, Netflix is having to spend materially more on new content while its existing catalogue is depreciating faster, but user engagement is barely improving. That suggests the efficiency of its content investment is weakening, with each additional dollar spent generating less incremental engagement than in previous periods.

We think this is the key takeaway from the quarter and one that was largely overshadowed by the focus on revenue growth and the Warner Bros. Discovery headlines. If this trend persists, investors may begin questioning whether Netflix can continue justifying higher content spending if the incremental return on that investment continues to decline.

Q2 Beat Looks Less Cheap Once Earnings Are Normalised

That said, it’s not all as bearish as it may initially appear.

While we’ve started with a more cautious view of the quarter, the termination of Netflix’s agreement with Paramount ultimately looks like a favourable outcome. Paramount paid approximately US$9 billion to secure Warner Bros. Discovery’s content library, taking on a significant amount of debt in the process. The company now faces the difficult task of integrating those assets while supporting a more leveraged balance sheet.

Netflix, by contrast, exited the arrangement and received a US$2.8 billion termination payment, which was recognised during the first quarter. The business also continues to demonstrate exceptional profitability, with operating margins of around 33%, highlighting the strength of its subscription model and ability to generate consistent cash flow.

However, the Paramount termination payment introduces an important valuation consideration that we think many analysts have overlooked.

A common bullish argument has been that Netflix is trading on a trailing P/E multiple of around 23x, or roughly 42% below its five-year average valuation. The problem is that this earnings figure includes approximately US$0.52 per share from the one-off termination payment, which was recorded within Interest and Other Income rather than generated through Netflix’s core operations.

If that non-recurring gain is excluded to better reflect the company’s underlying earnings power, trailing diluted EPS falls from roughly US$3.18 to around US$2.66, implying a trailing P/E closer to 28x rather than 23x.

Netflix still appears cheaper than its historical average, but the valuation discount is materially smaller than many investors believe once earnings are normalised. That doesn’t necessarily change the long-term investment case, but it does suggest the stock isn’t quite as inexpensive as headline valuation metrics imply.

The Stock Looks Defensible, But Not Cheap Enough Yet

Despite our concerns, there is still a compelling bullish case for Netflix.

The core investment thesis remains intact. Operating income continues to grow at more than 20%, demonstrating that the business is still expanding profitability at an impressive rate. At the same time, Netflix continues to aggressively return capital to shareholders. The company has authorised US$27.1 billion of share repurchases and bought back US$4.7 billion of stock during the quarter, reducing the diluted share count by around 2% over the past year.

That combination is important because investors don’t need valuation multiples to expand in order to generate attractive returns. Shareholder value can still be created through continued earnings growth, supported by a steadily shrinking share count.

This marks a meaningful change from where Netflix stood two years ago. At the time, the stock traded on around 36x earnings, meaning much of the expected return relied on investors continuing to pay an elevated valuation multiple. Today, that momentum premium has largely disappeared, and the investment case is far less dependent on multiple expansion.

As a result, we think Netflix’s current valuation looks considerably more defensible. “Defensible” doesn’t necessarily mean cheap, but rather that investors are less likely to be punished simply for owning the stock. There is now a credible base case where continued earnings growth, margin expansion and ongoing buybacks can deliver attractive shareholder returns, even if the valuation multiple remains broadly unchanged.

That said, the metric we will be watching most closely over the coming quarters is whether Netflix’s significantly higher investment in content begins translating into stronger engagement and accelerating growth, particularly in the UCAN (United States and Canada) region. If the additional billions being deployed into content fail to improve viewing hours, subscriber engagement and ultimately revenue growth, questions around the return on that investment will become harder to ignore.

For that reason, we think patience is warranted. Waiting for evidence that content spending is producing better engagement comes at a relatively low cost. With Netflix now trading on a more reasonable valuation and supported by one of the largest buyback programs in the market, we think the stock is unlikely to move 30% higher before investors receive another meaningful data point. That is a very different setup from mid-2025, when the shares were trading at a much richer premium and expectations left far less room for disappointment.