Is Netflix a good investment?
Opdateret: apr. 20
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.
I really like Netflix 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. I just wanted to give you full disclosure before I continue with the 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
We have determined that Netflix has a brand moat albeit a bit weaker than we would like. However, we really do 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 we will look into 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. The numbers are not disastrous but they are certainly not as good as we would like.
The next numbers we will look into 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 does live up to the requirements in all benchmarks. It has decreased a bit in the latest benchmark but it is hardly anything to be worried about, when it is as high as it is.
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. You cannot really point at anything negative at all, as the lowest benchmark at 32 % is still a fantastic number.
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 5 years benchmark and forward the numbers are evening increasing. It is safe to say that Netflix shows very impressing numbers.
Finally we look into the Cash Growth Rates. This is certainly worrisome as they are in minus in all of the benchmarks but one. It is not unusual to see some companies havening an outlier in one of the benchmarks and then you would investigate that further. In this case the negative numbers seem to be the norm and not an outlier, meaning you cannot blame it on one bad year.
To shortly summarize the five numbers from Netflix. The most important numbers are the ROIC and they are very underwhelming, as they don't live up to the requirements in any of the benchmarks. 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 and Equity Growth Rates. However, the numbers in the Cash Growth Rates are disastrous meaning they are not really making any real profit. I'm not really impressed with the overall look at the numbers.
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 7,91 years earnings in debt, which is unacceptable. You could 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. Another risk is their rather large debt, which is something to be monitored, especially when they seem to have a hard time making profit.
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 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.
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 as it is now at 5,93. I chose a Estimated future EPS growth rate of 15 (which is usually the highest possible growth rate I use), 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 $177,90, 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 $88,95 (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( Cash flow and income statement). However, it is not possible to calculate a ten cap price for Netflix as their operating cash flow is negative. Meaning you will have a negative numbers one you have done the formula: Operating Cash Flow - Maintenance Capital Expenditure + Tax provision / Outstanding share x 10.
The last calculation is the pay back time. It is also described in "MY STRATEGY". However, it is not possible to do so neither. The Free Cash Flow Per Share is $-14,26, meaning you will have a negative number once calculating the payback time price.
I do believe that Netflix is good company and I really like the management. However, all things considered , I would not open any position in Netflix. If it hit the margin of safety price, I would have a look again, as the sector has a lot of growth potential but it is so far off from what Netflix is trading at right now that I think it wont ever happen.
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 instead or check out my portfolio every now and then. If you believe we are facing a volatile period in the stock market, I did share some of my other investment ideas in order to build your wealth in this post. I hope that you will find inspiration.
Some of the greatest investors in the world believe in karma, and in order to receive, you will have to give. If you appreciated my analysis and want to get some good karma and show your appreciation, I would kindly ask you to donate a bit to AnimalsAsia. It is an organization that does a lot of great work such as saving bears from those disgusting bear bile farms. If you have a few bucks to spare and you enjoyed my writing, you would receive lots of good karma, if you would donate a little here. Every contribution matters no matter how little. Thank you.