Other News

Netflix: Top Growth Stock, But Don’t Expect A Dividend

cfd trading tips

Content streaming service Netflix (NFLX) has enjoyed a first-mover advantage in content distribution over the years. The company’s business has evolved immensely since its beginning, and despite some starts and stops in growth, it has been able to expand globally to tens of millions of subscribers.

This growth has afforded the company the ability to expand its content library – both on an original and second-run basis – to become a top-tier content distributor. However, its chronically-high valuation has us cautious on the company’s total return prospects in the coming years. Investors should also not expect Netflix to pay a dividend any time soon.

Growth Avenues Abound

Netflix started in 1997 as a DVD-by-mail service and largely struggled in its first few years to generate cash. The company’s primary competitor at the time was now-defunct rental chain Blockbuster in what turned out to be a battle for the future of content distribution. Netflix began streaming in 2007 and has never looked back, eventually introducing its first original series in 2013. Today, the service has about 150 million subscribers globally, including 60 million in the US.

Netflix provided its Q1 letter to shareholders on 4/16/19 and in it, the company described another record reporting period. Average streaming paid memberships soared 26% year-over-year, while average revenue per user, or ARPU, fell 2% due to currency headwinds. Excluding currency translation, ARPU would have risen 3% against last year’s Q1.

Total revenue growth was 22% in Q1, compared with a 40% gain in last year’s Q1. On a currency-neutral basis, Q1 revenue was up 28% against the year-ago period. Last year’s comparable revenue gain also benefited from several pricing changes that took place at the end of 2017, so those results aren’t necessarily directly comparable. Either way, Q1’s top line gain was once again very impressive.

Operating margin came in at 10.2% of revenue and earnings-per-share was 76 cents against 64 cents in last year’s Q1. Part of the gain in earnings in Q1 was due to a non-cash unrealized gain in forex re-measurement on the company’s Euro-denominated debt. Even so, operating margin fell markedly from the 12.5% produced in last year’s Q1 thanks to rising costs.

While Netflix continues to produce sizable growth, management believes it is far from done. Netflix sees 60 million to 90 million subscribers in the US over the long-term, compared to the 60 million it has today. While we don’t think Netflix is done growing in the US, it is certainly the most mature market the company has. Thus, the majority of future growth will need to come from other parts of the world.

The good news is that Netflix, as large as it is, currently enjoys only a sliver of global downstream internet traffic.

Source: Q1 shareholder letter, page 5

Netflix believes this gives it the runway to continue to grow for many years, including both inside and outside the US. The company has experienced some struggles with content preferences outside the US, as well as political obstacles. But despite these headwinds, it continues to grow subscribers internationally, adding a staggering 25 million in just the past year to today’s total of 89 million. The company continues to forecast strong international subscriber growth for the foreseeable future.

Recommended Stock Investing Posts:

  • Traditional IRA vs Roth IRA
  • The 80-20 Rule For Larger Returns
  • The Neatest Little Guide to Stock Market Investing Review
  • Teaching Children to Invest in Stocks
  • Leveraged ETFs vs Futures and Options
  • Invest In Small Cap Stocks
  • The Intelligent Investor Review
  • Using Behavioral Finance to Your Investing Advantage

We see potential saturation in the US and ever-rising content costs as key headwinds in the coming years. We believe revenue will continue to rise at rapid rates given subscriber growth internationally, as well as periodic pricing increases. However, the company’s US subscriber base is already at the low end of its long-term guided range, so it will take considerable work to continue to meaningfully boost the US subscriber base. Netflix has added about 5 million US subscribers in the past year, so growth hasn’t plateaued just yet, but it is something to keep an eye on.

Content streaming costs continue to rise in what has been an ever-present problem for Netflix since it began streaming more than a decade ago. Its content streaming obligations are up to $18.9 billion from $17.9 billion a year ago and we believe this will continue to increase as time goes on. Netflix’ original content should theoretically drive subscribers for shows that they cannot get anywhere else, and also should be cheaper to produce than buying content from other providers and streaming it. That may help offset some of the company’s rising content obligations, but we also note that the vast majority of Netflix’ content library is still purchased, not produced.

While we’re somewhat cautious because of these factors, we still see spectacular earnings growth ahead for Netflix. Indeed, we think it can grow earnings-per-share at 18% annually for the next five years as the company’s model matures a bit more and produces higher revenue. Margins remain in focus given content costs, but Netflix is a long way from being done growing.

Expected Returns

We see Netflix producing low to mid-single digit annual returns moving forward, as its high rate of growth is largely offset by a sky-high valuation we feel needs to come down. Indeed, we forecast $3.50 in earnings-per-share for this year, meaning that the stock is currently trading for 108 times this year’s earnings. We see fair value at 50 times earnings in the coming years based upon the way the stock has been valued in the past, its unique and very successful model, and the fact that it continues to find ways to grow despite its immense size. Even so, the stock is more than double where we assess fair value. This will present a mid-teens headwind to total returns as we think the valuation needs to come way down over time.

Netflix doesn’t pay a dividend, so the forecast 18% annual earnings growth and ~14% annual headwind from a lower valuation mean that total returns for shareholders that buy today will be in the low to mid-single digits. The stock is up more than 500% in the past five years, including doubling just since the beginning of 2018, so we believe a lot of growth has already been priced in, which significantly reduces future returns.

Recommended Dividend Investing Posts:

  • 3 Reasons to Consider Dividend Growth Stocks
  • The Value of Stocks Which Pay Dividends
  • How to Build Wealth with Dividend Investing
  • How Dividends Impact the 4% Safe Withdrawal Rate in Retirement
  • Dividend vs Growth Stocks – Choosing The Best Investment

Final Thoughts

We see Netflix as a premier growth stock, but one that has already enjoyed an enormous run in the share price. This run has caused the stock to be quite overvalued in our view, and for that reason, we do not recommend buying it today.

Netflix faces potential saturation in the US as well as ever-rising content costs, which will collectively make it more difficult to grow than it has been historically. In addition, the share price is more than double our generous estimate of fair value, and the stock doesn’t pay a dividend. Given all of these factors, we rate the stock a sell, and recommend investors wait for a lower price.

NFLXtweets


The post Netflix: Top Growth Stock, But Don’t Expect A Dividend appeared algo trading online.

binary options account manager
Rate this!
[Total: 0    Average: 0/5]