Is Netflix the Perfect Stock?

Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Netflix (Nasdaq: NFLX  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Netflix.

Factor What We Want to See Actual Pass or Fail?
Growth 5-Year Annual Revenue Growth > 15% 25.8% pass
  1-Year Revenue Growth > 12% 25.1% pass
Margins Gross Margin > 35% 37.7% pass
  Net Margin > 15% 7.3% fail
Balance Sheet Debt to Equity < 50% 134.3% fail
  Current Ratio > 1.3 1.71 pass
Opportunities Return on Equity > 15% 54.6% pass
Valuation Normalized P/E < 20 58.80 fail
Dividends Current Yield > 2% 0% fail
  5-Year Dividend Growth > 10% 0% fail
       
  Total Score   5 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

Netflix weighs in with a mid-range score of 5. Yet for a relatively young company, Netflix has been doing a lot of smart things lately.

Having helped send Blockbuster into bankruptcy, the company that pioneered mail-delivered videos hasn't rested on its laurels. Increasingly, subscribers are taking advantage of Netflix's arrangements with game console makers like Sony (NYSE: SNE  ) , Microsoft (Nasdaq: MSFT  ) to stream video directly over the Internet to the Playstation, Xbox, and Wii. Although Amazon.com (Nasdaq: AMZN  ) and Apple (Nasdaq: AAPL  ) offer similar streaming, they do so on a piecemeal pricing basis rather than Netflix's monthly subscription.

That hasn't stopped competitors from trying other models. Coinstar (Nasdaq: CSTR  ) offers video rentals at its Redbox kiosks, and NCR (NYSE: NCR  ) isn't letting the Blockbuster name die as it ramps up its competing Blockbuster Express kiosks. But so far, Netflix has shown no signs of slowing down on the path to domination in the industry.

So what's not to love about Netflix? The biggest concern is valuation, although high-growth companies often sport high multiples throughout their early years. And although Netflix doesn't pay a dividend now, it has the free cash flow to support one once it stops reinvesting as much money into its business and pays down some of its debt. For now, though, shareholders are quite content with the stock's huge capital appreciation in recent years.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Want to own the perfect stock? Click here to read our special report, 5 Stocks the Motley Fool Owns -- And You Should Too.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Apple, Amazon.com, and Netflix are Motley Fool Stock Advisor recommendations. Motley Fool Options has recommended a diagonal call position on Microsoft, which is a Motley Fool Inside Value pick. The Fool owns shares of Apple and Microsoft. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 20, 2010, at 1:14 PM, BioBat wrote:

    Netflix may be the perfect company but they don't have the perfect stock.

  • Report this Comment On October 20, 2010, at 4:08 PM, langco1 wrote:

    pretty soon at its current ridiculous price netflix may be the perfect short....

  • Report this Comment On October 20, 2010, at 4:14 PM, CPACAPitalist wrote:

    A good company, but PPS has a lot of hype built in.

  • Report this Comment On October 20, 2010, at 5:47 PM, mikecart1 wrote:

    Good company, just priced about $100/share over what it should be priced at. NFLX is about to make a lot of smart shorters very very rich. In that case, it would be the perfect stock.... to short. muhahahha

  • Report this Comment On October 20, 2010, at 8:28 PM, rcalverson wrote:

    Netflix may not be prefect, but I'm loving it all the way to the bank!!!

  • Report this Comment On October 21, 2010, at 10:48 AM, Amusebouche wrote:

    I started tracking nflx in 11/09 at around $60.00 a share in one years time that's a185% return, whats not to love.

  • Report this Comment On October 21, 2010, at 1:40 PM, scanlin wrote:

    After a big run up like today (at 172 now) I would consider a buy-write for Nov. The Nov 165's are paying an annualized return-if-flat of 44%, and they give you 7.5% downside protection for the 30 days until expiration. Even the Nov 155s offer 22% annualized return-if-flat (with 12% downside protection).

    MikeS

    http://www.borntosell.com

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