David P. Sims, CPA Blog | Will Netflix Ever Disappoint Investors? | Talkmarkets
Certified Public Accountant

David Sims is a Certified Public Accountant residing in Richmond, Virginia.

Will Netflix Ever Disappoint Investors?

Date: Monday, December 5, 2016 4:03 PM EDT

As we near the top of the economic cycle, one has to wonder when the next bear market will hit the economy. Unemployment is at a 9-year low. GDP growth is finally breaking through 3%. Seems to be healthy economically speaking, but that is also reflected in current market valuations, which are near higher than normal. If interest rates begin to step up, in any real sense, we could face a bear market in equities, or worse, a recession.  That's the cycle.

That brings me to Netflix (NFLX), which someone recently asked me about as an investor. It's been over a year since Carl Icahn exited his Netflix position booking a nice profit of $1.6 billion. When a billionaire like Icahn cashes out, I notice. The easiest to notice about the stock, and most obvious red flag, is the valuation. The stock trades at a Price to Earnings (PE) multiple of 322. Looking forward at future earnings, the figure is 125 time earnings. 

Flip the PE ratio and express this as an earnings yield. You will see that the return on investment is less than 1% per year, expressed as an earnings yield. It's clear that investors don't care about this earnings figure and they are more concerned with some earnings number that is ten or twenty years in the future. In other words, the investors in this company aren't valuing the business based on today's operations. 

That creates a lot of risk. My friend that recommended Netflix to me said something about the great original content. Sure. Netflix has great content. That's how they got the current subscriber base.  However, the internet is filled with new and interesting content. Just look at YouTube, Amazon Prime, Hulu, or any number of other startups breaking into this space. For creating new content, there are no barriers to entry. Yes. That's what I said. Content creation has no barriers to entry, except your imagination, of course. 

So, what's the justification for a PE multiple of 322? There is none.

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Comments

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Ayelet Wolf 4 years ago Member's comment

Loved "Stranger Things" on #Netflix. Original content can certainly lead to new subscribers. I have many friends who joined Netflix just to watch House of Cards, or HBO to watch Game of Thrones.

David P. Sims, CPA 4 years ago Author's comment

I watched most of the Game of Thrones series on Netflix, but then got HBO for free when I tried to cut cable. Now, I will probably just cancel my cable for 24 hours and get it again for free.

Carol Klein 4 years ago Member's comment

Interesting read but I have to take issue with your comment that "For creating new content, there are no barriers to entry." How can you say that? Creating a quality TV program or movie can take hundreds of millions of dollars. Especially if it involves a cast with star power. #Netflix and #Amazon definitely excel at this. Personally I think #Hulu and #YouTube fall short. $NFLX $AMZN

David P. Sims, CPA 4 years ago Author's comment

My kids sit around watching YouTube videos for hours that people created in their living room. The people create this content for free. Quality is in the eye of the beholder.

Kevin Richards 4 years ago Member's comment

How old are your kids? I'm not saying that your children don't have refined tastes, but there's a ton of crap on YouTube. My 5 year old can watch YouTube all day too, but my older kids have more sophisticated palates when it comes to the TV they consume.

Bindi Dhaduk 4 years ago Member's comment

YouTube has a mix of everything. You can find great content on YouTube, you just have to know where to look.