It doesn’t matter whether you are a growth or value investor. Netflix, Inc. (NASDAQ:NFLX) has proven to be one of the greatest investing challenges in stock market history. The price of NFLX stock has gone far beyond what any growth investor would consider reasonable, to say nothing of the hysterics that the shares cause in value investors.
The truth is that NFLX stock is driven entirely by momentum investors, and institutions that can’t afford not to be invested in Netflix stock because their clients would be screaming at them. Call it deeply ingrained FOMO, or a fear of missing out.
On a valuation standpoint, NFLX is impossibly and preposterously expensive. Yes, its product is outstanding. I love Netflix content. Yet the stock has always given me pause.
Is there any way that its recently announced price increase justifies the $87 billion market cap? Let’s check it out.
Based on its most recent financial reports, here’s the situation with Netflix stock: Trailing 12-month net income is about $360 million. The previous TTM net income was $141 million, so the increase was about 160%. That puts NFLX stock at 238x earnings. This is, amusingly, almost exactly the same multiple carried by Amazon.com, Inc. (NASDAQ:AMZN), but downright stratospheric compared with the 40x of Facebook Inc (NASDAQ:FB)
That comes on a 34% increase in TTM revenues, to $10.2 billion from $7.62 billion.
NFLX stock thus trades at 8.5x revenues. Amazon trades at 32x revenues. Facebook trades at 15x revenues.
There is a significant difference, though, when it comes to cash flow. Amazon is outrageously expensive, and while Jeff Bezos appears to be playing a very long game in terms of growing Amazon, his company generates almost $9 billion TTM free cash flow. Operating cash flow is almost twice that amount.
Netflix is burning cash so fast, it’s a wonder its doors are still open. In 2015, NFLX burned through $750 million. In 2016, that number almost doubled. The company is shelling out $6 billion for programming in 2017 and said yesterday that it will boost that by as much as a third next year.
This is the primary difference between these two overvalued stocks. Amazon’s business is generating tons of cash. Netflix is burning it all and scrambling to continually draw down debt.
That’s all well and good if, like Amazon, profits will eventually accrue to significant levels. Netflix has another long-term advantage in that it is building a library which should carry value over time. In theory, Netflix could license or sell outright its content to other streaming providers such as Hulu or even Amazon, or even to network or off-network syndication. The library wouldn’t have as much value as libraries did in the old days, because many Americans already have Netflix, so offloading that content to other providers may not generate much revenue.
The fee increase for the two-stream and four-stream plans increased by $1 and $2 per month, respectively. In parsing the subscriber numbers globally, and assuming that roughly 75% of subscribers have one of these plans, the cash flow situation would improve. Cash flow burn would be cut nearly in half. Net income would rise, possibly to something near $750 million, but not until 2020.
Bottom Line on NFLX Stock
Even assuming NFLX stock doesn’t move for the next three years, it is still wildly overvalued on a P/E basis.
So what’s an investor to do? Personally, I would wait for a big market crash, and then buy in at a far lower price. Barring that, one could go long. Now, you take a risk in doing so before earnings get reported because any little miss is going to knock 15-25% off the stock price. I would wait until after earnings, buy in, and set a stop loss at some level that represents what you are willing to lose.
Alternatively, I would sell naked puts against Netflix stock, collect the premium, and have a short-sale stop-loss in place in case the stock is put to you and drops.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com. As of this writing, he did not hold a position in any of the aforementioned securities.