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It has been easy to make fun ofNetflix in recent years. Skeptics have had a jolly old time as the streaming-video company's stock plummeted alongside its profits. The wags were conspicuously silent on Thursday, however, as the company's fourth-quarter earnings report sent the shares up almost 40 per cent; they are up 165 per cent since October.

Subscribers grew by 2.5 million in the quarter, more than double the number added in the prior quarter, and profit beat expectations. CEO Reed Hastings talked about a "virtuous cycle" in which Netflix adds subscribers, then adds more video content, attracting more subscribers, and so on.

This comment implies that the costs of buying more content, and serving more viewers, are more than offset by the revenue new subscribers add. Netflix's financials, it may seem churlish to point out, provide little cause for believing this. Recall how Netflix has changed in the past few years. In 2010, it was a capital-light business with a 13-per-cent operating margin.

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Its return on invested capital (ROIC) was 35 per cent. Then content and operating costs ramped up, compressing margins, and a bigger content library inflated the balance sheet. ROIC in 2012 was under 3 per cent. The view that Netflix will translate resurgent subscriber growth into resurgent returns depends on the idea that subscriber revenue will create operating leverage. Yet cost of goods sold (mostly content costs) per subscriber is not falling as the subscriber count rises.

While marketing and technology costs were stable in the fourth quarter, they easily outgrew revenue for the year. Subscriber growth drives Netflix's share price, and anticipating more of it is a good reason to own the stock. It is not a reason to think that the company's business model is virtuous. And that is no joke.

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