Does Netflix’s Big Earnings Make It A Buy?
In the last few months, I’ve written two separate articles telling you to avoid buying Netflix stock to protect your retirement portfolio.
Today, I give an update after its latest earnings and answer – Does Netflix’s Big Earnings Make It A Buy?
You can read the past articles in full by using the links above…
But if you don’t want to; here’s a quick recap of why I’ve told you to avoid it in the past before we get to today’s update.
From Article #1 Linked Above
- It’s Enormously Overvalued
Normally in these articles I talk about other things like debt levels and the negative affects the coronavirus is having on a company’s financials, and other things.
But frankly those don’t matter much right now with Netflix being so overvalued and competition increasing enormously.
As of this writing Netflix is a $215.9 billion market cap video and TV show streaming company that is massively overvalued.
Its P/E is 81.2.
Its P/CF can’t be measured due to its negative free cash flow… I’ll talk about this more in reason #2 to avoid Netflix.
And its forward P/E is 76.3.
On all these metrics I look to buy investments below 20 to consider them for investment.
Netflix’s valuations are far above these levels.
Its market valuation is so high that Netflix is as of this writing the 22nd largest company in the world when sorted by market cap.
In one sense this enormous valuation makes sense…
Netflix is the leader in streaming content worldwide for videos, movies, TV shows, and documentaries.
But competition is increasing rapidly which is causing its costs to rise dramatically… This is reason #2 to avoid Netflix.
2. Increased Competition Leads To Higher Costs
In 2007 Netflix owned an estimated 91% of the “video streaming market.”
Today it owns an estimated 19% of that same market it helped pioneer.
Netflix has an estimated 182.8 million subscribers as of April 2020.
Amazon Prime Video has an estimated 150 million as of January 2020.
Hulu has an estimated 30 million subscribers as of March 2020.
Disney+ has an estimated 54.5 million as of March 28th 2020… This only 4 months after launching in November 2019.
And these are just a few of its largest competitors…
CBS, ABC, ESPN, NBC, Apple, and many other media giants are also getting into the streaming arena.
This is leading to higher costs for Netflix.
Because many of these other companies – namely Disney – already have years or decades worth of original and exclusive content they can put on their individual platforms.
This content is exclusive to those platforms. Which means it’s taken off places like Netflix.
As one example, Disney has Marvel properties, Star Wars, Mickey Mouse, Toy Story, and access to its huge decades long back log of other iconic characters and properties.
Until recently, Netflix had zero original content. So, they had to pay huge sums to develop and create things from scratch.
And this spending leading to negative free cash flow is accelerating…
One example of this is that Netflix plans to spend $17.3 billion on content acquisition and creation in 2020.
By 2026 analysts expect Netflix to spend up to $26 billion on content acquisition and creation.
This is tens of billions of dollars Disney won’t have to spend to buy or create content from scratch.
Once Disney launched its Disney+ streaming service in November all its past content got removed from Netflix and put on its own platform.
This hurts Netflix.
And it’s also a large reason Disney+ has so many subscribers already after only a few months.
The high valuation combined with the increased costs leading to negative free cash flow make Netflix a risky investment that I recommend you avoid.
From Article #2 Linked Above
This thesis to avoid Netflix – even though I expect it to perform well during this pandemic – continued playing out on October 20th, 2020 when Netflix released its most up to date quarterly earnings.
- Revenues rose 23.1% in the year-to-year quarterly period to $6.4 billion.
- Paid memberships rose 25% in the year-to-year quarterly period to 195 million subscriptions.
- And somewhat surprisingly operating margin and net profit both rose in the year-to-year quarterly period.
Netflix produced fantastic results in this horrible economy… And as mentioned in the earlier article, these impressive results should continue.
But nothing in this quarterly update solved the 2 key issues I raised in the earlier article…
- Extreme Competition Leading To Higher Costs And Lower Profits
As of this writing Netflix’s P/E is 88.8.
Its P/CF is still negative because of negative cash flow.
And its forward P/E is 60.6.
It’s still extremely overvalued.
And it’s still dealing with rapidly growing competition.
The overvaluation right now is the bigger concern with Netflix’s margins rising in the year-to-year quarterly period.
When you invest in stocks that have a margin of safety it makes the investment safer. And it also means you should expect to earn higher returns owning it in the coming years.
The inverse of this is also true…
When you invest in a stock without a margin of safety it makes the investment riskier. And it also means you should expect to earn less owning it going forward.
With Netflix being overvalued by a large amount it makes the investment riskier.
And one quarter isn’t enough to make a declaration that increasing costs and lower profits are no longer an issue.
Again, I don’t think Netflix will blow up… I expect it to continue performing well.
But for these 2 reasons continuing, I recommend you avoid investing in its stock…
Because I’ve already recommended better potential investments to you.
This thesis to avoid Netflix stock continued to play out since I last wrote you about it back in July… Even though it released great quarterly numbers on January 19th, 2021.
- Revenue rose 21.5% in the year-to-year quarterly period to $6.6 billion.
- Paid memberships increased 21.9% in the year-to-year quarterly period to just under 204 million people worldwide.
- And in the full 2020 fiscal year revenue jumped 23.8% to $25 billion from $20.2 billion in 2019.
This is all great, so why am I saying the thesis to avoid Netflix stock continued to play out?
Because operating profit margins and free cash flow fell in the quarter as I predicted… And its valuation is still enormous.
Due to increased competition from the likes of Disney+ and other streaming options mentioned above, Netflix spent $11.8 billion on “additions to content assets” in 2020 alone.
This caused operating profit margin to fall from 20.4% in the 3rd quarter of 2020 to 14.4% in the 4th quarter of 2020.
Meaning, for every $1 in sales, Netflix now generates 14.4 cents in operating profit compared to 20.4 cents before.
In one quarter this meant its operating profit dropped from $1.32 billion in the 3rd quarter of 2020 to $954 million in the 4th quarter of 2020.
And these content additions also led to a massive swing from positive $1.2 billion in free cash flow production in the 3rd quarter to negative $284 million and unprofitability in the 4th quarter.
This fall in operating profit and cash flow will continue for a while as more companies get into the streaming game.
On top of this, its still enormously overvalued…
But its even more overvalued now because its profits and cash flow fell.
Its P/E is now 93.
Its P/CF is 106.
And its forward P/E is 58.5.
Because these two issues continue, you need to keep avoiding its stock.
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Disclosure – Jason Rivera is a 13+ year veteran value investor who now spends much of his time helping other investors earn higher than average investment returns safely. He does not have any holdings in any securities mentioned above and the article expresses his own opinions. He has no business relationship with any company mentioned above.