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Jonathan Poland
Jonathan Poland
Articles (492)  | Author's Website |

Netflix Is Cinderella at the Ball

Subscribers are a requirement for its business, but not a reason to buy the stock

October 17, 2018 | About:

Investors and analysts continue to fawn over Netflix (NASDAQ:NFLX) despite increased competition and absurd valuations. Here's a list of what Wall Street analysts are saying about the company after yesterday's earnings.

Netflix provides streaming video on demand available in virtually every country worldwide except China. The company produces its own content and buys content from third parties, many of them big name traditional media companies. Netflix is by far the leader in Internet-connected digital entertainment, but despite the number of investors propping up its stock, the time will come when its price gets cut in half. Will that happen when the stock is at $500 or is that right around the corner? I couldn't tell you, but remember this quote from Warren Buffett in his letter to shareholders in 2000.

"The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities ¾ that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future ¾ will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There's a problem, though: They are dancing in a room in which the clocks have no hands."

Netflix is that Cinderella, but the problem is no one can tell when the clock will strike midnight. Everyone is upping their price targets and calling the company's stock a buy despite massively overvaluation.

No one can argue with the company's success. As it transitioned from movies by mail to streaming, Netflix's revenue increased from $1.3 billion to $13.8 billion and net income from $83 million to $990 million. In the latest quarter, Netflix added 6.96 million new subscribers, bringing the total memberships up to 130.14 million. The company expects to add over 9 million subscribers in the fourth quarter as it pushes annual income over $1 billion.

The company deserves a growing market value, but its current capitalization is over $150 billion, which is just $20 billion shy of Disney's. Disney isn't going anywhere. Disney isn't being put out of business by Netflix. In fact, Disney could take share away from Netflix once its streaming service is released and pushed hard to the masses. Of course, consumers could choose both, but just looking at the numbers of these companies should demonstrate why Netflix is grossly overvalued.

Disney (NYSE:DIS)
Revenue: $57.9 billion
Gross %: 45.0%
Income: $12 billion
Mkt Cap: $172 billion

Revenue: $13.8 billion
Gross %: 38.1%
Income: $990 million
Mkt Cap: $150 billion

The market is factoring in far too much dominance going forward for the Netflix brand. Major cable and internet providers could become strong competitors if Netflix CEO Reed Hastings is right about cable being for news and sports only. Netflix isn't the only company that can put together a shiny app and connect content through the internet.

From an accounting standpoint, the company produces negative cash flow. Sure it might book an accounting profit, but it bleeds out more than $1.5 billion a year. Again, compared to Disney, which generates close to $10 billion a year in free cash flow, Netflix looks like it's barely treading water. If it were valued the same as Disney, the market cap would be cut considerably, dropping down in the $42 billion range. Keep that in mind if you decide to jump on the bandwagon.

Disclosure: I am not long/short Netflix or Disney. 

About the author:

Jonathan Poland
I spent more than 15 years helping DIY investors earn over 30% a year. Today, I help business leaders take those insights and build better assets. Thanks for reading. Do your own analysis before investing. Good Luck.

Visit Jonathan Poland's Website

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