Calling it “a message to the tyrants of Tehran”, he warned in a speech at the Munich Security Conference: “Do not test Israel's resolve.”
His fiery comments came as tensions between the arch enemies have mounted after clashes involving Syrian forces this month, sparked by Israel's downing of what it called an Iranian drone sent from Syria.
With a theatrical flourish, Netanyahu brandished a rectangular piece of dark green metal at the podium.
“Here's a piece of that Iranian drone, or what's left of it, after we shot it down,” he said.
Referring to Iran's Foreign Minister Mohammad Javad Zarif, who spoke later in Munich, he said: “No doubt Mr Zarif will brazenly deny Iran's involvement in Syria.”
“Mr Zarif, do you recognise this? You should, it's yours,” Netanyahu said, adding that the Iranian official “lies with eloquence”.
Zarif responded by calling Netanyahu's speech a “cartoonish circus” which “does not even deserve the dignity of a response.”
The clash came as Netanyahu again slammed the 2015 nuclear deal signed by Iran and world powers, which is under threat by opposition from the administration of US President Donald Trump. Netanyahu compared the deal to the “appeasement” of the 1938 Munich Agreement that only emboldened Hitler, and said it allowed Iran to hide its continued efforts to build an atomic bomb.
“The sanctions relief that the deal provided has not moderated Iran… In fact it has unleashed a dangerous Iranian tiger in our region and beyond. Once armed with nuclear weapons, Iran's aggression will be unchecked, and it will encompass the entire world,” Netanyahu claimed.
Those accusations were dismissed by Zarif.
“We will not be the first ones to violate an agreement which all of us tried, in spite of Netanyahu's attempts, to achieve,” he said.
Israel has said it downed the drone on February 10 after it entered the country from Syria, and responded with a raid on what it said was the Iranian control systems for the craft in Syria. It marked the first time Israel publicly acknowledged hitting Iranian targets in Syria since the 2011 start of the civil war there. During the strikes, one of Israel's F-16 fighter jets was shot down, believed to be the first loss of an Israeli plane in combat since 1982.
Tensions between the two countries had already been building in recent months, with Israel fearing that Tehran is trying to establish a permanent presence in Syria as part of an effort to become a greater regional power in the Middle East.
The clashes this month have stoked fears of an escalated conflict between the two countries, even though both sides appear to want to avoid an open war for now, analysts say.
Russian senator Alexei Pushkov, addressing the Munich conference shortly after Netanyahu spoke, said: “OK, you bomb Iran, and then you do what, what happens next?” while saying the Iranian issue requires acting with “responsibility”.
It was not the first time Netanyahu, who is under pressure at home over a corruption inquiry, has made a dramatic show.
In 2012, speaking at the UN, he notably showed a simplistic drawing of a bomb with a lit fuse, supposedly indicating how close Tehran was to becoming a nuclear threat.
The Israeli military has claimed the drone was a copy of a US model captured by Iran in 2011, based on an analysis of the drone's debris.
Netanyahu reiterated Sunday that Israel would not let Iran obtain a permanent foothold in its northern neighbour.
“Through its proxies — Shiite militias in Iraq, the Huthis in Yemen, Hezbollah in Lebanon, Hamas in Gaza — Iran is devouring huge swathes of the Middle East,” he said.
“Israel will not allow Iran's regime to put a noose of terror around our neck,” he added. “We will act without hesitation to defend ourselves. And we will act if necessary not just against Iran's proxies that are attacking us, but against Iran itself.”
But he stressed that Israel was not the enemy of the Iranian people, and offered his condolences to the families of the people killed in an Iranian plane crash Sunday.
“We have no quarrel with the people of Iran, only with the regime that torments them,” Netanyahu said.
By AFP's Joseph Schmid and Michelle Fitzpatrick