• Glenn

Is Netflix a good investment?

Opdateret: 3. maj

This is my fourth post about the FAANG stocks. N stands for Netflix and in this analysis I will look into the company and determine if it should be part of your portfolio, and at what price.

This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.

For full disclosure, I should mention that I don't own shares in Netflix, and never have. I really like Netflix as customer though and I have been a customer for many years. It is my favorite of the streaming services as I like that they have movies and series from all over the world. However, even though I like the company, I will stay objective in this analysis.

Netflix is defined as a over-the-top content platform and production platform. It was founded in 1997 by Reed Hastings and Marc Randolph and is located in California. I believe most people know about Netflix, so I see no reason to go deeper into what the company does, instead we will look at the moat. Netflix is a well-known brand, which is so well-known that it is even used as part of a euphemism for sexual activity being "Netflix and chill". It gives Netflix some sort of brand moat, however I would argue that the brand moat is relatively weak. It is so easy to switch from one streaming company to another, and if the company does not provide the content you like, most customers wont stay because of the brand itself. Meaning I don't think it has as strong as a moat as I would usually like.

Their CEO is Reed Hastings. Besides being the CEO, he is also the cofounder of Netflix. His educational background is a Master's Degree in computer science from Stanford University. He doesn't credit his educational background for his entrepreneurial spirit though, instead he credits his time in the Peace Corps for that, as he believes it gave him a combination of service and adventure. During his time in the Peace Corps, he went to teach math in rural Swaziland for two years and regarding to his entrepreneurial spirit he has stated "Once you have hitchhiked across Africa with ten bucks in your pocket, starting a business doesn't seem too intimidating". Prior to founding Netflix he founded Pure Software, while the company was successful, he did have some managerial challenges. Once Pure Software (then Pure Atria due to a merger) was acquired by Rational Software, he left soon after, and spent two years thinking about avoid similar problems in his next startup. Those years were very beneficial for him as his way of leadership is now considered transformational. His approach to personal time off, travel policies, formal reviews and compensation packages are far from mainstream corporate America. You can read much more about his management style in the book "No Rules Rules". I really like his managerial style and I believe his results speak for themselves and it is safe to say that his is a very good CEO that you can trust

I believe that Netflix has a brand moat albeit a bit weaker than we would like. However, I really like the management. Now let us look into the big five numbers in order to see if Netflix does live up to our requirements for a strong moat. In case you want an explanation about what the big five numbers are, you can have a look at "MY STRATEGY" on the website.

The first number I will investigate is the return on investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all of the benchmarks. I was quite surprised to see that Netflix doesn't live up to the requirements in any of the benchmarks besides the last one. The numbers are not disastrous but they are certainly not as good as we would like to see.

The next numbers I will investigate are the Sales Growth Rates. Ideally the numbers should be above 10% in each benchmark and increasing. In contrast to the ROIC, the sales growth rates are great and are well above the requirement in all of the benchmarks.

The next numbers are the EPS Growth Rates. As with all other growth rates we want the numbers to be above 10 % in all benchmarks. It is safe to say that the EPS growth rates look fantastic in all of the benchmarks. It has decreased a bit in the last year but the number is still fantastic, and I wouldn't worry about it if I was considering investing in Netflix.

The Equity Growth Rate follow in the footsteps of the previous numbers. They easily meet the requirements of more than 10 % in each of the benchmarks. And looking for the 7 years benchmark and forward the numbers are even increasing. It is safe to say that Netflix has very impressing numbers.

Finally we look into the Cash Growth Rates. Once again Netflix shows great numbers and especially the later years look fantastic. It would be hard to imagine that their Cash Growth Rate could continue to grow as it has of late but you certainly like to see numbers like these if you are considering investing in Netflix.

To shortly summarize the five numbers from Netflix. The most important numbers are the ROIC and they are a bit underwhelming, as the ROIC only lives up to the requirement in the latest benchmark. The ROIC numbers are not disastrous but you would really need to see impressive numbers in the following growth rates to justify an investment in Netflix. You do see great to fantastic numbers in Sales Growth Rates, EPS Growth Rates, Equity Growth Rates and Cash Growth Rates as they are well above the requirement in all of benchmarks. With the ROIC also coming around in the latest benchmark, I would considering investing in Netflix based on the numbers, if I could get it at the right price.

Another important thing to look into is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. Doing the calculation on Netflix, I can see that Netflix has 5,73 years earnings in debt, which is higher than I would like. You can in some situations accept this amount of debt. It could be a combination of the five numbers being great and the debt being due to a purchase of some kind.

Like every other company, Netflix is facing some risks. The most obvious risks come from competitors such as HBO (AT&T), Amazon Prime and Disney+. As I wrote in the paragraph about the moat, I believe the streaming industry is very competitive and it is hard to keep competitors away, as you don't a have such a strong moat that keeps your customers from changing from one company to another. During 2021 Netflix has 222 paying customers compared to 179 million on Disney+, however, Disney is narrowing the gap. Another risk is their rather large debt, which is something to be monitored, especially when they seem to have a hard time making profit. Netflix has determined that they have 800-900 millions households around the world as potential customers. India is the largest potential market but Netflix cannot seem to get a footing in India. In order to try to get more Indian customers aboard, Netflix has lowered the subscription fee in India.

It isn't all bad for Netflix. A market analysis report from Grand View Research projects the global video streaming market size to grow by a compounded annual growth rate (CAGR) of 20,4 % from 2020 to 2027. Obviously Netflix will take their share of the growth but it might also be worth looking into other video streaming companies Furthermore, Netflix entered the world of mobile gaming in November 2021. The world's mobile gaming market is expected to grow by a CAGR of 12,6 % until 2026, and so far Netflix has only released 10 games, and they are expected to expand their portfolio in 2022. Finally, Netflix is expected to become free cash flow positive for the full year of 2022 and beyond, and reinvest that that cash in their core business and fund new growth opportunities as we have seen with gaming.

All right, we have gone through the numbers, potential and risk regarding Netflix, and now it is time for us to calculate a price for Netflix. In order to calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use a EPS at 8, which is between the EPS from 2020 and 2021. I chose a Estimated future EPS growth rate of 15 (which is usually the highest possible growth rate I use, and one Netflix expects to grow with), Estimated future PE 30 (which the double of the growth rate, as the historically PE for Netflix has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY", we come up with the sticker price (some call it fair value or intrinsic value) of $240, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Netflix at price of $120 (or lower obviously), if we use the Margin of Safety price.

Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". In order to do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating Cash Flow last year was 2.427,08. The Capital Expenditures was 497,92. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I wasn't able to find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 348,54 in our further calculations. The Tax Provision was 437,95. We have 443,4 outstanding shares. Hence, the calculation will be like this: (2.427,08 - 348,54 +437,95) / 443,4 x 10 = $56,75 in TEN CAP price.

The last calculation is the PAYBACK TIME. It is also described in "MY STRATEGY". However, with the Free Cash Flow Per Share that is negative, it is not possible to make this calculation.

I do believe that Netflix is good company and I really like the management. However, all things considered, it certainly is way too expensive for me to be interested. It is worth noticing that since my last analysis, Netflix has actually been profitable and also paid off some debt. Hence, Netflix might turn out to be an interesting investing opportunity in the future but as it is now, it trades way above the price I'm willing to pay.

My personal goal with investing is financial freedom. It also means that to obtain that, I do different things to build my wealth. If you have some extra hours to spare each month, you can turn a few hours a week into a substantial amount of money in a few years. If you are interested to know how to do it, you can read this post.

I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.

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