In this article, let's take a look at Netflix, Inc. (NFLX, Financial), a $28.9 billion market cap company that provides a subscription service streaming movies and TV episodes to more than 44 million subscribers in the U.S. and some international markets.
Business model
Netflix has become the best source for on-demand children's programming and past seasons of popular shows still running on cable networks.
Although the market believes that future sales growth and profitability will be outperforming, we recognize that the market is large but may necessitate generated cash flows in the future. In addition, the growth potential and the level of profitability are questioned based on the increasing competition and potential for content owners to retain most of the economic profits.
In order to gain incremental subscribers, Netflix must offer more value, which means that it always needs to improve its menu. Further, staying competitive on price is always a good strategy.
The company focuses to build a more attractive video-on-demand product for pay TV subscribers. Moreover, Netflix could transform to be the leading provider of Internet television in the U.S.
We have to mention that Netflix has a deep library of DVDs that is very important because it helps to build differentiation in the streaming business.
Fierce competition
The industry is intensely competitive and subject to rapid change. With respect to barriers to entry, they are quite low, and consumers can take multiple subscriptions and change them when they want to. The company faces a strong competition, from HBO GO or Showtime Anytime and video-on-demand content including cable providers, like Time Warner (TWC, Financial) and Comcast (CMCSA, Financial); satellite TV providers, such as DIRECTV (DTV, Financial) and DISH (DISH, Financial); and telecom providers such as AT&T (T, Financial) and Verizon (VZ, Financial). Other competitors are iTunes, Amazon.com's Prime Video, Hulu.com and Hulu Plus, Redbox, LOVEFiLM, Sky's Now TV, and YouTube. Also, from DVD rental outlets like Blockbuster and Redbox; and video retailers, such as Best Buy (BBY), Wal-Mart (WMT, Financial) and Amazon.com (AMZN, Financial).
Revenues, margins and profitability
Looking at profitability, revenue growth by 25.34% led earnings per share increased in the most recent quarter compared to the same quarter a year ago ($1.15 vs $0.49). During the past fiscal year, the firm increased its bottom line by earning $1.85 versus $0.29 in the prior year. This year, Wall Street expects an improvement in earnings ($3.90 versus $1.85)
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| NFLX | Netflix | 8.43 |
| AMZN | Amazon.com Inc. | 2.81 |
| Â | Industry Median | 9.09 |
The company has a current ROE of 8.43%, which is lower than the industry median but higher than Amazon. It is very important to understand this metric before investing, and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 144.9x, trading at a premium compared to an average of 23.1x for the industry. To use another metric, its price-to-book ratio of 17.91x indicates a premium versus the industry average of 1.98x while the price-to-sales ratio of 6.04x is above the industry average of 0.82x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $103.189, which represents about 60% compound annual growth rate (CAGR).
The share price has more than tripled since October 2012, from $60 to more than $380 per share in April 2014. The earnings growth of nearly 135% contributed to the stock to increase by 75% over the past year.
Final comment
The company seeks to grow the subscription business with focus on improving the customer experience, principally extending its streaming service to more Internet-connected devices. This sounds great because the internet era is increasing while the DVD market is declining.
I think the business will continue growing, providing value to subscribers, while advances in technology make things work more efficiently.
According to what we discussed in the article, I would recommend to add this stock to long-term portfolios. Hedge fund gurus like Joel Greenblatt (Trades, Portfolio), Andreas Halvorsen (Trades, Portfolio), Chase Coleman (Trades, Portfolio), Julian Robertson (Trades, Portfolio), John Burbank (Trades, Portfolio) and Ron Baron (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
