Netflix has completely transformed the DVD rental industry. There was a time that you used to have to hop in your car and drive to a movie rental store if you wanted to watch a movie at home. That day is long gone, thanks to Netflix. Netflix made it possible to have movies shipped directly to your home by mail and have movies streamed directly to your television. Netflix is truly a transformative company with a plethora of movie titles but the stock is not a great investment for new investors looking to buy.
The business is still solid and the fundamentals are strong but the valuation is simply too high. Netflix has been able to grow earnings at a 45% rate over the past three years with 21% revenue growth. Operating margins of 13% and return on equity of 65% are superior to the industry average. The problem is the stock trades at 43 times book value and nearly two times the historical growth rate. Netflix trades at nearly 45 times the amount of cash flow that the company generates.
Netflix has been a great growth stock over the past five years. The company now has over 20 million subscribers and has seen its stock price rise from the low $20s to over $235 a share. The stock has just gotten too expensive for investors to buy shares based on the projected growth of earnings. Netflix trades at 80 times last year’s earnings and 54 times next year’s earnings. That is a lofty valuation for any company–even one with the great historical growth of Netflix. Achieving 30% annual growth rates will not be easy.
The DVD rental company is no longer the young upstart that is taking aim at the bigger boys in the industry. Netflix is the dominant force in the movie rental industry and now faces more competition from on demand movies, Redbox and Blockbuster. Amazon and Facebook are long term competitors as well. Netflix will have to spend more money just to maintain its present status and keep its competition from eating away at its market share.
Netflix may have dominated the DVD industry but the company faces a whole lot more competition in the streaming movie industry. At $235 a share, Netflix is just too expensive to take the leap on at this level.
Mark Riddix is the founder and president of New Horizons Financial Management, an independent investment advisory firm that provides personalized investing and asset management consulting. Mark is a regular contributor to Seeking Alpha and has written financial columns for Baltimore and Washington, D.C. area newspapers. Mark publishes his own financial blog, BuylikeBuffett.com and has written the book Your Financial Playbook.