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Cramer pinpoints the key strategy driving Netflix's success

  • "Mad Money" host Jim Cramer lists three key things that Netflix CEO Reed Hastings is using to his company's advantage.
  • Understanding what the stock market is willing to pay for is Netflix's main driver, Cramer says.
  • By using technology in conjunction with art, Netflix proves there really is a science to what people like to watch, the "Mad Money" host says.

In light of Netflix's strong earnings report, Jim Cramer knows CEO Reed Hastings understands three things: content can be king, people love bargains, and bigwig money managers will invest in internet stocks with promise.

"Netflix is, to the naked eye, a two-pronged success. If your company can produce local content that people love worldwide and you only charge them $8 or €8 a month, you'll land and expand. You'll grow and grow and grow," the "Mad Money" host said.

But the third element, the willingness of Wall Street financiers to catch and pay for the next hot internet-related trend, was what really drove Hastings' success so far, Cramer said.

By using technology to deliver popular programming, Netflix was able to capture investors' attention (and wallets) despite losing swaths of money on production expenses.

"As Reed says, 'Negative free cash flow will be an indicator of enormous success,'" Cramer said. "In other words, Netflix is an entertainment company but is being valued as a tech company, as money managers believe it's all well and good to lose money now if you're going to dominate later."

After listening to Netflix's post-earnings conference call, Cramer touted the company's simple, cutthroat model. Once the streaming giant figured out the content people liked, it offered them a bargain on the cost of content, hence the negative cash flow.

Not only was the $8-per-month price enticing, but Cramer said it helped Netflix fend off rivals, as any company that tries to compete with that cost will end up erasing its own gross margins.

Then, Netflix incorporated artificial intelligence to keep its audience hooked by analyzing user data and offering recommendations based on customers' watching activity.

"Last night's extraordinary quarter was a triumph of science masquerading as art," the "Mad Money" host said.

The science came from Netflix using the stock market as a source of capital so that it can continue losing money on its huge amount of content while keeping costs low, Cramer said, adding that if Netflix wanted to turn a profit, it could simply cut back on content or raise costs.

"It's the same model as Amazon. Money managers backed Amazon because they knew, at a certain point, if they wanted to, they could raise the price of Prime offerings to make more money," he said. "The more Netflix knows about what people love, what you love, the more it can scale that love into not profits — as so many thought were needed — but subscribers. And by that metric, do you know that the stock of Netflix remains undervalued? Which is why, even after this run, it is still not too late to buy Netflix."

Watch the full segment: Cramer's '3 reasons why' for Netflix

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