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Netflix: Is it time to invest in this market leader?

Opdateret: for 2 timer siden


It is usually wise to invest in market leaders, and Netflix is a prominent player in the video streaming industry with significant potential for growth. However, investors seem to disagree on whether Netflix is a good investment. Bill Ackman quickly divested from his investment, whereas Phil Town has been acquiring the stock. Warren Buffett stated in an interview on CNBC in April 2023 that "the streaming business is tough." In this analysis, I will investigate whether Netflix is a good investment and determine its optimal purchase 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 briefly go through why the company has meaning to me. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. 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 start by mentioning that at the time of writing this analysis, I do not own any shares of Netflix. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I don't own any stocks in Netflix's competitors either. Thus, I have no personal stake in Netflix. If you want to purchase shares or fractional shares of Netflix, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.



The Business


Netflix is defined as an over-the-top content and production platform. It was founded in 1997 by Reed Hastings and Marc Randolph and is headquartered in California. I believe most people are familiar with Netflix, so there is no need to delve further into the company's operations. However, it may be useful to know that Netflix generates 44% of its revenue in North America, 31% in Europe, the Middle East, and Africa, 13% in Latin America, and 11% in the Asia-Pacific region. Netflix is a widely recognized brand, so much so that it has become synonymous with the phrase "Netflix and chill," which is often used as a euphemism for engaging in sexual activity. It gives Netflix a certain brand moat. Management has also discussed their competitive advantage, or "moat," in a recent earnings call. They mentioned that they view themselves as a unique product that cannot be easily replaced by alternatives. Nonetheless, I would argue that Netflix's brand moat is relatively weak because it is easy for customers to switch from one company to another if a streaming service does not provide the content they prefer. Therefore, I don't believe that Netflix has as strong a moat as I would prefer.


Management


Netflix has two co-CEOs, Ted Sarandos and Greg Peters. Ted Sarandos first joined Netflix in 2000 and became the co-CEO alongside co-founder Reed Hastings in 2020. Besides being the co-CEO, he is also the Chief Content Officer at Netflix. Ted Sarandos led Netflix into original content production in 2013. He also spearheaded the teams responsible for acquiring and creating some of Netflix's most successful series, including "Stranger Things," "Squid Game," "La Casa de Papel," "The Witcher," "The Irishman," and "ROMA." He is recognized as an innovator and has previously been named one of Time magazine's 100 Most Influential People. He also appears to be popular among employees, as he has an employee rating of 81/100 on Comparably, placing him in the top 5% of companies of similar size. Greg Peters first joined Netflix in 2008 and became the co-CEO in January 2023. Before being named co-CEO, Greg Peters held various positions at Netflix, including Chief Operating Officer and Chief Product Officer. Greg Peters has been responsible for managing Netflix's global partnerships with consumer companies, internet service providers, and multi-channel video programming distributors. These partnerships enable Netflix to distribute its products across a wide range of devices and platforms. Besides being the co-CEO of Netflix, Greg Peters also serves on the boards of 2U Inc and DoorDash. We don't have much information on Greg Peters yet, as he is still new to the role. I believe that combining the diverse experiences of Ted Sarandos and Greg Peters is a beneficial idea that will work well for Netflix in the future. Therefore, I feel comfortable with the management at Netflix. It is worth noting that the former CEO and co-founder, Reed Hastings, will continue to serve as the executive chairman of the board.


The Numbers


The first number I will investigate is the return on invested capital, also known as ROIC. Ideally, you would like to see a return on invested capital (ROIC) above 10% every year. Historically, Netflix has had an underwhelming return on invested capital (ROIC). However, they have moved in the right direction since 2017 and have maintained a 10% Return on Invested Capital (ROIC) in the last four years. Nonetheless, I cannot help feeling a bit underwhelmed by these numbers, and I would like to see a higher return on invested capital (ROIC) moving forward. I believe that monitoring Return on Invested Capital (ROIC) is important to determine if Netflix can sustain a ROIC above 10% in the long term, even with its recent positive trend.



The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. These numbers are much more encouraging, as Netflix has managed to grow its equity year over year in the last 10 years, except for 2023. And even more impressive, Netflix has continuously managed to deliver a growth rate higher than 10% each year in the nine years that it has expanded its equity. I'm not overly concerned about equity decreasing slightly in 2023, as Netflix has historically delivered strong performance. While the return on invested capital (ROIC) was underwhelming, these numbers are promising.



Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow margin is used because I believe that margins provide a better understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Netflix has not delivered the desired level of free cash flow that one would expect from a company in which you would like to invest. In the past decade, Netflix has only achieved positive free cash flow in three out of the last ten years. Management has stated, however, that they expect to achieve positive free cash flow from now on. It is very encouraging that Netflix delivered its highest free cash flow ever in 2023, and hopefully, this trend will continue. Levered free cash flow margin has been low or negative in most years, but Netflix managed to deliver a high levered free cash flow margin in 2023, which is very encouraging. The free cash flow yield has improved, but it is not as high as I would prefer to see. This suggests that the stock is expensive. However, we will delve into this further later on.



Debt


Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a period of 3 years. Upon calculating, I found that Netflix has 2,62 years of earnings in debt. It is below the three-year threshold. Hence, debt is not a concern when investing in Netflix.


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Risks


Like every other company, Netflix is facing some risks. The most obvious risk is competition. The streaming industry is fiercely competitive. Warren Buffett has remarked that "the streaming business is tough." Warren Buffett's reasoning is that people have only 24 hours in a day and two eyes, making it difficult to increase demand. Furthermore, streaming businesses lack a strong competitive advantage, making it challenging to prevent customers from switching between companies and difficult to retain them. Furthermore, Netflix is not only competing against other streaming companies; large tech companies such as Amazon and Apple are also focused on expanding their streaming businesses. Netflix also competes against other forms of entertainment, such as social media.


Content Costs. One of Netflix's key strategies is its investment in original content to attract and retain subscribers. However, producing and acquiring content is very expensive, and there is always the risk that the company's investments in new shows or movies will not yield the expected return in terms of attracting new subscribers or retaining current ones. Netflix's content costs are largely fixed in nature. This implies that Netflix's business could be adversely affected by lower growth and lower margins if they fail to continuously achieve a high return on investment on its content.


Macroeconomic factors. In previous letters to shareholders, management has mentioned that inflation, sluggish economic growth, and geopolitical events could have an impact on their business. Economic downturns can lead to consumers cutting back on discretionary spending, including subscriptions to services like Netflix. Thus, if we observe a prolonged recession in any of Netflix's key markets, it could adversely impact Netflix's business.


Reasons to invest


There is also plenty of potential for Netflix moving forward. One is an expanding market. A market analysis report from Grand View Research projects that the global video streaming market size will grow at a compound annual growth rate (CAGR) of 18,5% until 2030. Not only is the global video streaming market size growing, but Netflix also has ample opportunity for further expansion within the current market. Management has mentioned that they capture about 5% of consumer spending and 10% of the TV time in their most mature markets. Management believes they have a huge opportunity ahead of them in Netflix's core business as there are hundreds of millions of qualified households out there that have not yet signed up for Netflix.


Advertising. Netflix has launched an ad-supported cheaper subscription model. Netflix is currently expanding its business as it continues to grow rapidly, reaching 23 million monthly active users by the end of 2023. Netflix wants to build a big and profitable ad business. Management has mentioned that they are very optimistic about the advertising business and see it as a huge opportunity. They shared that there is $180 billion of ad spend outside of China and Russia, with $25 billion spent solely on Connected TV. Management said that they know ad dollars follow engagement and believe that they have the most engaged audience. So, they believe they are well-positioned to capture some of the advertising expenditure that shifts from traditional linear TV to streaming platforms. Furthermore, they also mentioned that the margins on the advertising business are expected to remain very high.


Sport entertainment. Netflix has entered the world of sports entertainment by acquiring the rights to WWE Raw starting from January 2025. WWE offers 52 weeks of live programming every year, which could attract new subscribers. Management believes that WWE has historically been under-distributed outside of North America. They hope that global distribution will attract more international customers to Netflix. Furthermore, management has also mentioned that they could develop shoulder programming around WWE, similar to what they have done in other sports such as Drive to Survive, Full Swing, Breakpoint, Quarterbacks, and Tour de France.


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Valuation


Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.


The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 12,03, which is from the year 2023. I have selected a projected future EPS growth rate of 15%. (Finbox expects EPS to grow by 21,3% per year over the next five years, but I have chosen to use 15% as the highest rate.) Additionally, I have chosen a projected future P/E ratio of 30, which is twice the growth rate. This decision is based on the fact that Netflix has historically had a higher P/E ratio. Lastly, our minimum acceptable rate of return is already set at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $360,90. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Netflix at a price of $180,45 (or lower, obviously) if we use the Margin of Safety price.


The second calculation is called the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company is essentially its return on investment. The minimum annual return should be at least 10%. I calculate it as follows: The operating cash flow last year was 4.620, and the capital expenditures were 360. I attempted to analyze their annual report in order to determine the percentage of capital expenditures allocated for maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 252 in our calculations. The tax provision was 797. We have 432,76 outstanding shares. Hence, the calculation will be as follows: (4.620 – 252 +797) / 432,76 x 10 = $119,35 in Ten Cap price.


The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Netflix's free cash flow per share at $15,82 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $249,73.


Conclusion


I believe that Netflix is an intriguing company with good management. The absence of a moat is somewhat concerning to me, but considering the recent performance of Netflix, it is evident that Netflix is the top player in the industry. Investing in the leading company in the industry is typically a strategy I favor. Netflix faces some short-term risks due to macroeconomic factors, but these risks typically do not persist. Content costs are a risk that Netflix will always face. However, so far, Netflix has been doing a great job in achieving a high return on investment, and there is no indication that this trend will change in the future. Competition poses a significant risk due to the lack of a competitive advantage, especially as major tech companies increasingly prioritize streaming services. Nevertheless, Netflix remains a dominant player in the market. I like that Netflix is operating in a growing industry and has the potential to expand its core business further. I believe that Netflix's foray into live sports entertainment will help attract new customers. Additionally, if WWE expands internationally, it could have a positive impact on Netflix as well. I appreciate Netflix's efforts to expand its advertising business, which has the potential to significantly boost Netflix's profitability in the future, given the high margins associated with advertising. I have mixed feelings about Netflix because I am concerned about the weak moat but on the other hand, Netflix has delivered some impressive numbers in the past year. Nonetheless, due to the weak moat, I will require a margin of safety when investing in Netflix. Thus, I will only invest in Netflix if it reaches the Payback Time price of $249,73.


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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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