Why Netflix Is Still Cheap Despite 30% Gain In Three Weeks

(Note: The author of this fundamental analysis is a financial writer and portfolio manager. He and his clients own shares of NFLX and DIS.)

Valuing companies can at times be more art than science because for the most part, how each investor values a business can be very different. One such example is Netflix Inc. (NFLX) stock.

According to reports, Argus Partners argued that Netflix valuation is significantly above its peers. But does Netflix honestly have any peers? Most of the players in the space are not pure plays, making a peer analysis difficult. And when valuing Netflix purely on future earnings growth, the stock is cheap and may be worth nearly 40 percent more than its current price. 

Analysts are looking for Netflix to earn $6.46 per share in 2020, and with NFLX trading at roughly $255, the stock is trading at only 39.7 times 2020 earnings estimates. When adjusted for growth, the valuation comes down significantly, because Netflix is expected to grow at a compound annual growth rate (CAGR) of about 55 percent from 2018 to 2020.

Fundamental Chart Chart

Fundamental Chart data by YCharts

Why The Stock Is Still Cheap

When looking forward, Netflix becomes significantly cheaper, because its PEG ratio drops below 1 to 0.72. Companies such as Walt Disney Co. (DIS) trade at a two-year forward PE of about 15, but is only expected to grow by a CAGR of about 6.5 percent over the next two years, giving the stock a PEG ratio of nearly 2.5. (See also: Understanding The P/E Ratio.)

Could Be Worth $355

Should Netflix trade at or in-line with its growth rate to bring its PEG ratio up to one, its PE ratio would have to rise about 55, and that would make the stock worth about $355.

But with a growth rate that high and a high earnings multiple, any slowdown in growth or perceived bump in the road would come with significant pain, likely causing the stock price to drop sharply. 

Fundamental Chart Chart

Fundamental Chart data by YCharts

No Direct Peers

While figuring out the correct way to value Netflix is not easy, to compare it to any company at this point seems unfair. For example, Disney is more than just a media company, because it has theme parks and merchandise sales. And while Disney will likely be a significant player in the future of direct-to-consumer streaming media, at this point it's not there yet.  

Amazon.com Inc. (AMZN) is the dominant force in e-commerce, and while it has a video platform, there seems to be no precise number around how many active subscribers the service has, making it hard to value. 

Netflix at this point is the only public company that is a pure play on the delivery of online content. Some would debate that Roku Inc. (ROKU) is one, but Roku generates nearly 53 percent of its revenue from selling its hardware device, with the balance coming from advertising, not content. 

Given the growth outlook and past success, should Netflix continue to meet or beat expectations, the stock price still has much further to climb. 

Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdingsInformation presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance. 

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