Stock Analysis ON Netflix (NFLX): All I want for Christmas… is your Netflix password

Yvonne Fan, London School of Economics and Political Science

Overview:

When you hear “Netflix”, what comes to your mind?—— The Queen’s Gambit, Stranger Things or Money Heist? Indeed, all of these are big-hit productions that have gained steam since their teaser and official release, amassing tens of thousands of avid binge-watchers who are enthralled.

Netflix started as a DVD rental company in 1997 via domestic mail and repackaged as a subscription model after a year since establishment. Now, it has grown into a mega online streaming company hosting 203m subscribers.

Netflix IPO-ed on Nasdaq in 2002 and has since thrived with rapid growth in stock price (500% over the past 5 years). What are its growth and value drivers, and whether the current stock price reflects its intrinsic value? Continue reading to find out more.

Selling Point Analysis:

As of 13th September 2021, Netflix’s enormous market capitalization of $265b currently ranks 33rd in the world, with a share price of $598.72. Not only did Netflix’s stock grow by 14.51% YoY, but it also exhibited technical supremacy as evidenced by its 3-month outperformance compared to NASDAQ’s ETF by 4.9%. In search of alpha, institutional investors have swamped in, including big names like Blackrock, Morgan Stanley and UBS.

In the midst of a fierce streaming war where potent competitors continue to emerge, Netflix unwaveringly remains the leader. In terms of market share in the US in 2021, Netflix’s share of 20% still tops the list as compared to Prime (16%), Hulu (13%), Disney+(11%) and Apple TV (5%), pointing to market dominance and business resilience.

Needless to say, part of Netflix’s superb performance is galvanised by the global pandemic, where nationwide lockdowns forced people into navigating entertainment options online to dispel boredom and kill time. But this pandemic-led acceleration is essentially industry-wide. So, what made Netflix stand out from its peers?

Netflix’s growth and value drivers:

  • Netflix boasts an unparalleled diversity of content, including many exclusive productions such as The Crown and Stranger Things. They are also heavily re-investing in new content and have set their 2021 content investment target to US$12b.
  • The seamless HD experience is well-loved and acts as a barrier to entry for smaller companies and new entrants that lack state-of-the-art cloud technology to store and deliver a large volume of content. Smaller streaming companies in their early stages lack sufficient funds to compete with moguls like Netflix.
  • Netflix wins the hearts of subscribers via their customisation of content. It has effectively utilised a computer algorithm to analyse user preferences and recommend suitable content for them. Since 2017, Netflix has pioneered a cutting-edge algorithm that sets up personalised video thumbnails for its 200m+ subscribers, thus hooking them to the screen.
  • With its strategic price differentiation across countries with varying purchasing power, Netflix is able to maximise its revenue and earnings. For instance, a basic monthly subscription costs $9.0 in Singapore but only $3.3 in Argentina.
  • Netflix is also going to experiment with innovative strategies such as adding games into its exclusive basket. The diversification efforts are promising to drive growth and reduce risks.

Indeed, these successes are reflected in Netflix’s remarkable financial metrics:

  • Revenue for 2020 was $25b, representing a 24% YoY growth. From 2016 to 2020, Netflix’s revenue jumped consistently with an average growth rate of 29.8%, exceeding that of 7.79% of the S&P 500.
  • Netflix’s net earnings rocketed 63.8% over the last year, much higher than the industry average growth of 10.8%. In the past 5 years, Netflix has triumphed over an average yearly earning growth of 51%, surpassing the industry average of 26.3%.
  • Netflix’s ROCE (Return on Capital Employed) in 2020 was 18%, exceeding the industry average of 10%.
  • The net profit margin is 18.4% (2021 Q2 MRQ), signalling decently high profitability compared to S&P 500 (12.3%).

Moreover, in the most recent shareholder letter, Netflix’s CEO announced that the company would not require raising capital from shareholders anymore, implying financial sustainability over the long run and the prevention of stock dilution for stakeholders. 

Risk Analysis

However, there are two sides to every coin and Netflix is no exception. The gradual economic recovery worldwide potentially reduces the growth rate of subscribers for Netflix, as lockdowns ease and “Working From Home” is no longer an alternative. Moreover, rife competition in the streaming industry with newcomers may further squeeze Netflix’s revenue and earnings, leaving it with a smaller slice of the pie.

Furthermore, certain parts of its financial performance do not prove satisfactory:

  • Netflix’s P/E is 60.3x, much higher than the industry average of 26x, suggesting possible overvaluation.
  • Netflix’s PEG is 2.6x and thus considered to be mediocre (>1x).

Recently, Netflix’s director Ann Mather has sold 809 shares, complicating the perception of the company’s future prospects.

Conclusion:

Netflix’s stock is likely to be worth a seat in a growth-focused portfolio as it started to gain even more momentum thanks to the global pandemic. 

P/E is comparably high because of Netflix’s ambitious expansion, coupled with efforts to combat new competitors, inevitably weighs on its net income. The difference between Netflix’s PEG and the benchmark 1x is not as drastic and within the acceptable range.

Though the risk of a declining consumer base is present, it is outweighed by the robust prospects of Netflix’s further penetration and expansion strategies in both the domestic and international markets, thus prompting future subscriber growth. Even as a reduction in subscribers really happens, Netflix is able to secure earnings with its high price-setting ability and customer loyalty as the dominant player in the market with the most diverse selection of content. 

Indeed, who doesn’t long for a cosy and safe “home cinema” experience with the dull winter approaching and the Covid-19 rumbles never ceasing?

References:

  1. https://www.comparitech.com/blog/vpn-privacy/countries-netflix-cost/
  2. https://csimarket.com/stocks/growthrates.php?code=NFLX
  3. https://www.marketbeat.com/instant-alerts/nasdaq-nflx-insider-buying-and-selling-2021-09/
  4. https://markets.ft.com/data/equities/tearsheet/financials?s=NFLX:NSQ&subView=IncomeStatement
  5. https://simplywall.st/stocks/us/media/nasdaq-nflx/netflix#future-profit

Disclaimer: This article solely represents Yvonne Fan’s personal opinion and is by no means a legitimate investment recommendation.

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