Is Netflix Growing Foolishly?

I love a great growth company as much as the next stock junkie, but growth for growth's sake just doesn't cut it for me. I want to see a company grow Foolishly, creating value even as it expands.

Why isn't growth enough? Let's say I start a business that earns 10% returns on capital. Unfortunately, it cost me 12% to get the capital I needed to get my business up and running. That means my business doesn't generate enough of a return to pay back my investors. The more I grow, the further into the hole I sink. That's not very Foolish.

Online movie distributor Netflix (Nasdaq: NFLX  ) has produced Foolish growth for some time now. Its return on invested capital remains greater than 15%, while most companies' cost of capital comes in between 8% and 12%. So not only is it creating value, it's growing faster than the competition, as the following table shows:

Company

5-Year Sales Growth

ROIC

Netflix

25.8%

63.3%

DIRECTV (NYSE: DTV  )

12.3%

12.2%

Verizon Communications (NYSE: VZ  )

8.4%

8.6%

Source: Capital IQ, a division of Standard & Poor's, and author's calculations.

The Foolish bottom line
Value and growth are joined at the hip. If a company's management can't find ways to grow sales while earning positive spreads on its investments along the way, I'd just as soon keep my capital in my pocket. Fortunately, Netflix's track record of creating value as it grows makes it well worth considering.

Million Dollar Portfolio associate advisor David Meier does not own shares of any of the companies mentioned. Netflix is a Motley Fool Stock Advisor recommendation. The Motley Fool has a disclosure policy.


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  • Report this Comment On August 12, 2010, at 2:20 PM, Oughta wrote:

    One gotcha on their much touted Watch Instantly feature - it does not provide separate passwords for sub-accounts. This means that, unlike with the mailed DVD queues where parents can control what ratings their kids can see, the Watch Instantly uses the same password as the main login. This exposure technically violates CIPA (Children’s Internet Protection Act, which exposes Netflix board members to criminal prosecution). A grassroots effort to address this issue has met with corporate indifference. If the momentum on public opinion picks up speed, this could hurt the stock price until the issue is fixed and the PR mess is mopped up.

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