Why the Math Favors the Premium on Netflix Stock

Although NFLX stock is one of the hottest names this year, the long-term bull case is fundamentally supported

Recently, Forbes’ contributor Panos Mourdoukoutas offered up a frightening thought, at least if you’re vested in Netflix (NASDAQ:NFLX) stock. He suggested that the content-streaming giant is the new Tesla (NASDAQ:TSLA). That’s only a compliment if you arbitrarily consider only the first half of this decade. But over the last several months, TSLA has largely incurred serious volatility, portending bad news for NFLX stock.

NFLX Stock: This Is Why the Math Favors the Premium on Netflix
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Of course, that’s only if Mourdoukoutas’ analysis is accurate. However, he does bring up some valid points. After all, Netflix stock, just like TSLA, is considered a “hot stock” by investors. Investments like NFLX trade heavily on sentiment and popular themes. In this comparison, NFLX trades on the massive popularity of streaming, while TSLA moves on potentially transformative electric vehicles.

And although I’m broadly bullish on NFLX stock, I concede that Mourdoukoutas makes some great points. For instance, these two names don’t just trade on blind faith. Concerning Netflix, streaming has revolutionized and utterly disrupted traditional media broadcast. When people talk about cutting the cord, they almost always have Netflix in mind.

Furthermore, with Tesla, neither the company nor its CEO Elon Musk needs introduction. While I have contentions about Musk’s unforced errors, he is a genius. And at the very least, he has forced the automotive industry to reconsider its longstanding position on the internal-combustion engine.

Therefore, it’s easy for investors to believe that they’re riding a fundamentally sound narrative when they’re actually trading on sentiment. As we saw with Tesla, its fundamentals showed vulnerabilities, hence taking down TSLA.

Mourdoukoutas argues the same could happen with Netflix stock due to rising competition in the space, particularly with original content.

Why NFLX Stock Is Still a Long-Term Buy

Naturally, if you hold a substantial stake in NFLX stock, you want to know if Mourdoukoutas’ argument has merit. Under this context, I’m afraid it does. While Netflix is unquestionably a brilliant content creator, the company is not guaranteed to hold this lofty advantage forever.

But I think the real question is whether it’s likely that Netflix stock suffers the same fate as TSLA; as in, a massive deflation in its share price. Here, I believe NFLX stakeholders can have reasonable confidence in the company’s longer-term trajectory.

NFLX stock
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That’s because NFLX isn’t just a hot stock, but rather a growth stock. Obviously, this means that investors dive into shares because of the growth potential that will eventually transition to consistent earnings. Thus, a genuine growth stock should have a strong relationship between its price action and its top-line sales.

And that’s exactly what we see with NFLX stock. From the fourth quarter of 2006 through Q1 2019, the correlation coefficient between share price and revenue is 97%. From Q1 2013 through Q1 2019, we see an almost identical correlation strength.

In other words, as the company generates more revenue, Netflix stock moves higher.

But it’s more than that. Netflix’s revenue has gained tremendously in magnitude, and it matches the robust profits of NFLX. To put it simply, big revenue in Netflix translates to big returns in NFLX stock.

TSLA stock
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Mathematically, then, we can determine that Netflix is a classic growth stock. However, TSLA can’t quite say the same thing. From Q2 2010 through Q1 2019, the correlation between sales and share price is 76%. But from Q1 2013, that correlation dips to 68%, and from Q1 2015, to 66%.

Stated differently, TSLA is no longer a classic growth stock. Thus, it’s not the greatest comparison to Netflix stock.

Netflix Needs the Streaming Narrative to Stay the Course

Now before you load the boat with NFLX stock, let me clarify one point: just because TSLA is not the best example to compare Netflix with, it doesn’t mean the streaming giant’s equity will not suffer volatility.

Going back to one of Mourdoukoutas’ arguments, media behemoths like AT&T (NYSE:T) will challenge Netflix via its HBO acquisition. In the spirit of full disclosure, you should know that I bought T stock earlier this year. HBO was certainly on my mind when I did.

That said, my argument is that Netflix is a genuine growth stock. Therefore, as long as that growth narrative remains intact, shares should move higher. Historically, we have only rarely seen NFLX break below its fundamentals.

In my opinion, and the implied opinion of streaming-industry experts, the underlining sector can support multiple content creators. Therefore, Netflix has a strong consumer base from which it can grow both domestically and internationally. So, unless you have some compelling reason not to believe in streaming, I wouldn’t worry too much about NFLX stock.

As of this writing, Josh Enomoto is long T stock.

Article printed from InvestorPlace Media, https://investorplace.com/2019/07/why-the-math-favors-the-premium-on-netflix-stock/.

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