Netflix, Inc. (NFLX) Stock in 2016: A Y2K Cisco (CSCO) Redux?

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Irish author Edmund Burke once famously said, “Those that don’t know history are doomed to repeat it.” Little did Edmund know his words would one day serve as the perfect warning for investors in Netflix, Inc. (NFLX) stock, who risk the same fate as Cisco Systems, Inc. (CSCO) stock owners in the late ’90s.

nflxWhile the business world has evolved dramatically over time, human nature has remained more or less the same for centuries, and psychology and human nature are at the root of financial markets. The cyclicality of the stock market comes from emotions like fear and greed and motivations like stubbornness, envy and impatience.

Since investors in 1916 experienced these elements of human nature the same way investors do in 2016, market phenomena repeat themselves over and over again. Sure, the players may change, but the game is the same.

Today, I want to take a look at one of the darlings of the post-crisis bull markets, NFLX, and compare it to one of the darlings of the Dot-Com Bubble, CSCO, to see if history may once again be repeating itself.

NFLX & CSCO: Seeing Double?

When it comes to the bull case for NFLX stock, the 800-lb gorilla in the room is the stock’s astronomic P/E ratio, which sits well above 300. Without further context, it goes without saying that this valuation is absurdly high.

However, the rabid fans of Netflix stock will hardly let you get the words out of your mouth before they begin touting the company’s revenue growth rate, its rapid subscriber expansion, and the potential size of its global market. And yes, NFLX has been producing stunning revenue growth for a company its size over the past decade.

Here’s a graph of Netflix’s revenue, share price and P/E over the past five years:

NFLX1

Now let’s take a look at the same graph for CSCO from 1996 to 2000. Much like NFLX, Cisco was a tech giant with a huge market share and seemingly limitless expansion potential:

CSCO1

The Aftermath

How did things turn out for Cisco the company? Very well, actually. In the decade that followed the peak of the Dot-Com bubble, Cisco nearly tripled its revenue as it expanded its business. The CSCO stock price, on the other hand, which had become completely detached from reality during the bubble as its P/E ratio peaked above 200, fell more than 70 percent and never significantly recovered:

CSCO2

Where does that leave Netflix? NFLX stock is currently in the dangerous position of being so expensive that even the most generous growth estimates over the next ten years will still not be able to support the stock. In 2015, NFLX generated EPS of 28 cents. If Netflix were able to increase this number tenfold to $2.80, NFLX stock  would still sport a P/E ratio of 33.4, well above the tech sector’s average P/E of 23.3.

At some point, NFLX may be in a position to drastically improve margins, but its efforts to expand globally, generate more original content and negotiate third-party content deals will continue to weigh heavily on the company’s earnings for years to come.

The Bottom Line

There’s no denying that Netflix is an incredible company. However, there is a huge difference between an incredible company and an incredible stock. Many of those bullish on NFLX stock may think that the Netflix story makes it an exception to the rules of conventional stock valuation.

Don’t get sucked into that line of thinking.

Take a close look at some of the tech giants that owned the market during the Dot-Com Bubble, like CSCO, and try to imagine how exceptional and bright the future must have seemed for them at the time.

As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.

Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market.


Article printed from InvestorPlace Media, https://investorplace.com/2016/02/netflix-inc-nflx-stock-vs-cisco-csco-year-2000/.

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