Shares of video streaming giant Netflix Inc. (NFLX, Financial) are up a whopping 82% this year. This meteoric rise has pushed the company’s stock to a total market value of $152.38 billion, outstripping The Walt Disney Co.’s (DIS, Financial) market value of $152.31 billion.
Such has been Netflix’s performance over the last couple of years that the company’s stock price has more than tripled. The market sentiment has certainly improved in that time, following its global expansion in 2016.
But even more important is the fact that, despite the company’s stock price rallying more than 200%, its price-earnings ratio has dropped by more than 45% over the same period. In early 2016, shares of Netflix traded at a price-earnings ratio of about 380 times to 400 times, but that number is now down to about 230 times. Based on this metric, one would think that it is time to buy. But is it?
Perhaps the narrative would change if you looked at Netflix’s valuation horizontally rather than vertically. While Disney may not be the perfect candidate for comparison purposes, it makes sense to use it since the company is becoming bigger than Disney.
Compared to Netflix’s price-earnings ratio of about 230 times, Disney trades at just 13.7 times its earnings. In this case, a debate about whether the current scenario is a case of Netflix overvaluation or Disney undervaluation would make sense to most investors.
So, which one is it?
Netflix’s global subscriber numbers have soared over the last couple of years, helping the company grow its 2015 revenue by about 75% to $6.78 billion. Since then, revnue has grown to $11.7 billion.
As Netflix has continued with massive investments in content production, however, the company’s bottom line failed to match up to the progress in its top line. This trend is not about to change, even with last year’s spike in net income. Netflix plans to continue investing in original content and has recently ventured into producing theatre-level feature films, beginning with Will Smith’s Sci-Fi action film "Bright."
The company also recently inked a multimillion-dollar contract with former U.S. President Barrack Obama to produce a series of TV shows and films. So Netflix will continue to expand its video streaming empire for the foreseeable future, which makes the stock an interesting option for growth investors.
Its subscriber base also continues to widen, which means the trend represented in the chart below could continue for the next several years (rapidly growing top line and a modest bottom line).
This effectively weighs on the company’s profit margins, which are already dwarfed by those of Disney.
Netflix currently operates with a profit margin of about 8%, which is unimpressive in comparison to Disney’s operating margin of about 25%.
The global entertainment giant also boasts massive top and bottom lines, which trump Netflix’s numbers several times over. The company’s 2017 revenue of around $55 billion is up nearly 70% over the last seven years, while its bottom line of approximately $9 billion has nearly tripled from its fiscal 2010 value of about $3.3 billion.
Netflix’s top-line growth over the last two years might appear to trump Disney’s seven-year growth rate, but it makes perfect sense when you know that marginal growth decreases as the top line journeys higher.
So what trade-offs could Netflix and Disney shareholders be looking at as they continue to imagine the future returns from their investments?
One of Netflix’s strongest moats rests on its business model. The company’s no-ads subscription-based revenue generation model continues to attract investors with more customers growing tired of ad-supported platforms.
However, competition has started to rise over the last several years with the likes of technology giant Amazon.com Inc. (AMZN, Financial), Alphabet Inc.’s (GOOG, Financial) (GOOGL, Financial) YouTube and many other small players joining the market.
Nonetheless, Netflix continues to dominate, with investors comparing its disruption of the video streaming industry to what Amazon did to retail. Mainstream cable companies, which boast a huge market share in the cable TV industry, might threaten Netflix by launching their own no-ads subscription-based video streaming services, but it is important to note that retail giants like Walmart (WMT, Financial) have failed to topple Amazon since Jeff Bezos disrupted e-commerce.
On the other hand, Disney shareholders will be looking at the company's diversified business as an edge against Netflix. This gives it the flexibility to introduce new products without significantly shaking the stock price.
In summary, Netflix looks like a good growth stock, whereas Disney has the makings of a defensive stock. So, who takes the mantle from here on out? The two companies are currently neck-and-neck in terms of overall market value, but the picture will become clearer as investors continue to weigh their views on what could eventually become offense versus defense.
Disclosure: I have no positions in the stocks mentioned in this article.
