3 Reasons Why Netflix, Inc. (NFLX) Stock Is Worth Its Insane Valuation

Why would anyone pay 300 times earnings for a stock, let alone Netflix, Inc. (NASDAQ:NFLX), a company that made just $52 million in the third quarter from $2.2 billion in revenue?

3 Reasons Why Netflix, Inc. (NFLX) Stock Is Worth Its Insane Valuation
Source: Via Netflix

Even better, why would someone buy Netflix stock when in Q3 2016 it used $462 million more in cash then came in the door from subscribers?

For value investors, the answer’s an easy one. They wouldn’t.

But for those who can see past the financials, I see three big reasons to remain interested in Netflix stock. Not the least of which is the fact the Netflix stock price has barely budged over the past 52 weeks, up just 1.7% through Nov. 11. Indeed, NFLX is due for a move higher.

That said, it’s not easy for me to write about the upside potential of Netflix.

In September, I made the case why Amazon.com, Inc. (NASDAQ:AMZN) was a much better stock to buy than Netflix. Despite Jeff Bezos and Co. missing Q3 2016 earnings and revenue estimates, Amazon Web Services continues to grow by 50% or more each year, making it a very important piece of the Amazon pie.

But really, I just love how Amazon isn’t afraid to invest heaps of money in areas it feels have the greatest growth potential, regardless of the short-term hit to earnings. It’s truly amazing.

But there’s something to be said of Netflix for adding 3.6 million members in the third quarter, 57% higher than its forecast for the three-month period ended Sept. 30.

Netflix Still Growing

Netflix, Inc.’s subscriber growth represents a 4.3% increase in its global members, from 83.2 million at the end of Q2. As a result of its unexpectedly high sign-up rate, Netflix increased revenues in the third quarter by 36% year-over-year to $2.16 billion, the first time it’s gone over $2 billion in global streaming in a quarter.

Forget earnings. That’s a significant accomplishment, especially on a constant currency basis where global streaming revenues in Q3 were up 39%, or 400 basis points higher year-over-year.

Picking up three million members outside the U.S. each quarter, Netflix should see its international memberships overtake its U.S. memberships sometime in Q2 or Q3 2017. And that’s without China coming on board anytime soon.

Netflix has truly become a global business and the first global TV network.

House of Cards Meets the House of Mouse

A couple of days after InvestorPlace contributor James Brumley wrote about why he think it makes sense for Walt Disney Co (NYSE:DIS) to buy Netflix, fellow contributor Lawrence Meyers chimed in about the reasons why it doesn’t make sense.

Both arguments are good ones.

Brumley feels that Disney has to do something to pump up the tires of a lethargic ESPN subscriber count, while Meyers believes paying $45 billion or more to acquire an over-the-top television service that barely makes money is hardly a smart allocation of Disney’s capital.

Who’s right? I believe Brumley is.

Sure, buying Netflix would be Disney’s largest acquisition ever — it acquired Capital Cities/ABC in 1995 for $19 billion — and not an easy one to pull off, but the alternative is to pass on the video streaming company and sit idly by while a competitor of some description gobbles it up.

I just don’t think Bob Iger, Disney’s CEO, who is looking to retire at some point in the not-to-distant future, will want to go out on a sour note.

It might be a lot of money to pay, but it sends a signal to investors that Disney is serious about the digital world. And hopefully it’s enough to keep ESPN relevant for years to come.

Reed Hastings

As I said previously, Bob Iger is looking for the ideal person to replace himself at the head of the Disney table. Reed Hastings would be a logical candidate. He’s built a huge business from scratch, understands the entertainment business and the idea of convergence, and he knows how Disney operates considering Netflix’s existing pay-TV deal with the company.

It’s not easy to find good CEOs; Hastings, despite his company’s inability to generate free cash flow, is one of the best in the business. He might not be an internal candidate, but if DIS wants someone who can hit the ground running, I think he’d be at the top of the list.

Bottom Line on Netflix Stock

Netflix stock’s forward P/E is about half its trailing ratio, so we’re not quite in the nosebleed valuation zone, but we’re close. I believe that the value of a company to a large extent is what potential buyers are willing to pay.

You might not think a baseball player is worth $30 million a season, but if a team’s willing to pay that price, then the valuation, at least in their opinion, is more than fair.

At the end of the day, that’s all that really matters.

I might not pay 150 or 300 times earnings for Netflix stock, but eventually, somebody will, whether it’s Disney or another multi-billion corporation.

Netflix will be acquired. We just don’t know by whom.

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

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