Netflix (NASDAQ:NFLX) stock has not fared well in the past month. Shares in the streaming behemoth have fallen from $335.98 at the open July 29 to $291.03 at the close Aug. 27. NFLX continues to dominate the American streaming space. But, the company’s domestic subscriber space has stalled at 60 million. To mix things up further, Disney (NYSE:DIS) is launching its Disney+ service in November. With the other media giants following suit, the pressure is on for Netflix to create original content to retain subscribers.
With all of this in mind, is Netflix stock a buy? Shares continue to trade at an inflated valuation. With the recent pullback, a short-term rebound is possible. But in the long term, NFLX stock is more risk than opportunity.
Can NFLX Stay on Top?
With its subscriber-based revenue model, NFLX is willing to take risks on shows advertising-dependent media would not touch. This has won the company acclaim and prestige. But awards don’t keep the lights on. While Netflix’s stable of original content is high quality, subscribers are still largely watching reruns of content owned by the big media conglomerates. As AT&T’s (NYSE:T) WarnerMedia and Comcast’s (NASDAQ:CMCSA) NBCUniversal launch their respective streaming services, “The Office” and “Friends” (Netflix’s two most-streamed shows) will disappear from the service.
Outside of the big media conglomerates, Netflix’s digital native competitors are catching up fast. Roku’s (NASDAQ:ROKU) subscriber growth continues to surge. William Blair analyst Ralph Schackart projects that Roku will have 80 million subscribers by 2025. Apple (NASDAQ:AAPL) is launching Apple TV in November. Apple’s service will be similar to that of Netflix and Amazon’s (NASDAQ:AMZN) Prime video streaming service. This means even more money will be pumped into original content production. This may be a windfall for content creators. But it also means that NFLX will need to spend more to retain its current subscriber base.
Valuation: NFLX Stock Remains Priced for Perfection
In July, I mentioned how the company continues to trade at a high valuation. This remains the case. Netflix stock currently trades at a forward price-to-earnings ratio of 52. The stock’s Enterprise Value/EBITDA ratio is 69.6. This is leaps and bounds above the valuations seen by the big media conglomerates. Disney stock trades at a forward P/E of just 23.1. Its EV/EBITDA ratio is a rich but relatively cheap 18.7.
Looking at a more apples-to-apples comparison, let’s see how the valuation of NFLX stock stacks up to Roku stock. Since ROKU has both negative earnings and negative EBITDA, the Enterprise Value/Sales (EV/Sales) ratio is the closest metric we can use. Netflix stock trades at an EV/Sales ratio of 7.7, compared to 18.6 for Roku. This makes Netflix stock look relatively cheap. But Roku has plenty of runway before it hits the wall. Netflix, on the other hand, has reached critical mass.
Unless international growth is on fire, NFLX stock needs to come back down to earth valuation-wise.
One could say that NFLX will “grow into its valuation.” This means as the company matures, their operating margins will improve as the company spends less on scaling. But Netflix’s operating costs are going up. In 2018, Netflix spent $12 billion on content. But BMO Capital Markets analyst Daniel Salmon estimates content spending could balloon to $17.8 billion by 2020.
With this is mind, I doubt NFLX can reduce costs anytime soon. Unless revenues continue to surge, the company will have a tough time growing operating income. This will likely bring down the valuation of NFLX stock.
Netflix Stock Could Rebound, But Stay on The Sidelines
While I continue to be bearish on Netflix stock, I believe the company could see a rebound in the short term. NFLX has a history of crashing on negative sentiment, only to bounce back as it reinvents the wheel again and again. All bets are off whether NFLX can keep its subscriber base with original content alone. It takes time to develop programming that has decades-long popularity. Shows such as “The Office” and “Friends” are still reaping dividends from the entertainment industry’s past business model. Highly successful broadcast shows, they were reran continuously in syndication and on cable. This built up a substantial fan base, which has simply cut the cord and moved their binging to the streaming sphere.
Perhaps Netflix can create an original show with staying power. They could also steal some ideas from the Disney playbook, buying up existing franchises not owned by the other media giants. But for now, NFLX stock remains a gamble. For investors looking to ride the streaming wave, look for opportunities elsewhere.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.
