Dueling Fools: Why I'm a Netflix Bear

If you're a hard-core Netflix (Nasdaq: NFLX  ) fan like my fellow duelist Anders Bylund, wondering how anyone could possibly be bearish on the stock, let me start by saying this: I'm a value investor. As such, I like three things: cheap stocks, cheap stocks, and, well, I think you get the picture.

Does Netflix fit the bill? Let's take a look:

Valuation Metric

Netflix

S&P 500 Average

Revenue multiple 5.7 2.7
Price-to-book-value 43.1 3.5
Trailing price-to-earnings ratio 80 23.6
Forward price-to-earnings ratio 54.2 17.9
EBITDA multiple 38.6 11.1
PEG ratio 1.83 1.86

Source: Capital IQ, a Standard & Poor's company. P/E is before extraordinary items.

Maybe I'm missing something here, but based on this table, it looks like we'd have a pretty tough time calling Netflix a cheap stock. Sure, the bulls will be quick to jump at the PEG ratio, but even there, the multiple doesn't look cheap -- simply fair. And bear in mind that to get to that PEG ratio, you have to believe that Netflix can grow 30% per year over the next five years.

Giving the benefit of the doubt
But hey, I'm a reasonable guy. Let's suspend disbelief for a moment and assume that Netflix can grow 30% per year over the next five years. After all, it managed that growth rate over the past five years.

Alas, even if Netflix can grow that fast, the stock will face a strong cross-current as investors lower the valuation. P/Es of 80 are like a man with two left feet on a high-wire -- bound to fall.

Five years ago, among companies that, like Netflix, had a market cap of $10 billion or above, nine companies boasted a P/E above 75. Six of those companies have managed positive earnings-per-share growth over the past five years. Take a gander at what happened to their valuations:

Company

Market Cap Five Years Ago

P/E Five Years Ago

P/E Now

Trailing Five-Year Earnings-Per-Share Growth

Google $120 billion 80.1 21.2 36.1%
DIRECTV $21 billion 75.2 18.8 62.3%
Symantec (Nasdaq: SYMC  ) $18 billion 99.6 23.9 35.4%
Biogen Idec (Nasdaq: BIIB  ) $15 billion 96.4 20.9 53.2%
CA Technologies (Nasdaq: CA  ) $15 billion 77.6 16.5 29.2%
Celgene (Nasdaq: CELG  ) $13 billion 214.2 30 60.4%

Source: Capital IQ, a Standard & Poor's company.

A quick glance at the growth column shows that these companies kicked in some serious jets over the past five years. But heady growth or not, investors knocked down every single one of those valuation multiples, by significant amounts.

The average of the "P/E Now" column comes out to 22. What would happen to Netflix's stock if the company grew earnings per share at 30% per year, and its P/E multiple dropped to 22? Five years from now, investors would be sitting on a sweet, sweet 3% return. Total. (That works out to 0.5% per year).

And if serious competition from the likes of Amazon.com (Nasdaq: AMZN  ) , Hulu, Google, or Apple (Nasdaq: AAPL  ) actually does materialize, and Netflix doesn't notch 30%-per-year growth? Well, then, kiss that 3% goodbye.

In short, when it comes to Netflix, the risk/return on the stock is nowhere near compelling.

See fellow Fool Anders Bylund's bull case for Netflix, then come back tomorrow for my rebuttal to Anders' bullish argument.

Google is a Motley Fool Inside Value pick. Google is a Motley Fool Rule Breakers pick. Apple, Amazon.com, and Netflix are Motley Fool Stock Advisor selections. Alpha Newsletter Account, LLC has bought puts on Netflix. Motley Fool Options has recommended a bull call spread position on Apple. The Fool owns shares of Apple, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer does not have a financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


Read/Post Comments (6) | Recommend This Article (14)

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 April 20, 2011, at 6:58 PM, David369 wrote:

    Did I read this right...all of the 5 stocks appreciated in value? Ok, not like rocket stocks, but not like sinking boats either. The more I mess around with stocks the less I look at PE. I fail to see that it predicts anything useful except that a majority of investors are (rightly or wrongly) in love with that stock and are betting it will do well. Sometimes a run up in price is justified, and usually it is not. If I invested based on PE I would probably have a bunch of good investments giving me a fairly good return. I'm greedy. I invest in what has done well in the past and what I think will continue to do well in the next couple of years. When I bought NETFLIX for $17.90 it was "iffy" and today it is still kind of "iffy" but less so in my opinion. Will it fall off the rocket? Yes. When, who knows. Would I buy more today. Yes. I just watch for when the rocket engine stops so I can jump off. PE is probably nice for a classroom discussion in investing 101. I played hooky that day. Buy low, sell high seems to work ok. In my life I've probably bought & sold in excess of 200 stocks (some were repeats like AMZN & Apple & QCOM) and I can count on one hand how many I lost money on. If I looked at PE my investments might have been safer but not nearly as productive. So, you don't like NFLX because it has a high PE? How about potential of future growth? Is there an indicator for that...uh, or is that what PE might represent. I did play hooky that day you know. This is so confusing...

  • Report this Comment On April 21, 2011, at 11:53 PM, verylargelarry wrote:

    200 positions, 5 losers? You should be publishing. Or going to confession.

  • Report this Comment On April 22, 2011, at 9:42 AM, David369 wrote:

    I cheat. I look at the previous 2-5 year trend of the stock price. I think about continuing future business of that company and usually hold for 2 yr or more. Holding usually cures all ills for any but the most iffy companies. My biggest mistake was buying IPO Kryspy Kreme doughnut stock just because I like the doughnuts...lost about 75%. If I had held it long enough I would probably be ok today. Don't know really, would have to look. My rule now is wait at least 6mo to 1 yr after IPO and usually just don't buy into new companies at all. DIS, Coach, Amzn, Apple all good companies that keep going up with minor blips along the way. IMAX, RLD others currently going up fast but probably won't continue at the current pace but as long as doing well I will ride the wave. I never look at PE, I look more at historical trend and my confidence in the business to continue at least in the near future. Common sense and being lucky...can't teach that and I will never tell anyone what to invest in (bad luck for both of us). Best investing tool is the Stock Advisor newsletter which gives me ideas and explains pros & cons of business. Rule Breakers is good too but I like the SA stocks a little better even though I don't agree with all their recommendations. (Hey, you two brother Fools want to pay me for saying this?)

  • Report this Comment On April 22, 2011, at 9:44 AM, griffjj wrote:

    Yeah, that's ridiculous. You lose all credibility when you throw out numbers like that.

  • Report this Comment On April 22, 2011, at 7:38 PM, David369 wrote:

    I wish I did as well as the Stock Advisor newsletter but they have the advantage of many stocks and time to research. They have some losers, but percentage is really small considering some of their risky investments...well, what I would consider risky. Nothing ventured nothing gained I guess. That's probably why I don't do as well as them but my nerves aren't that good.

  • Report this Comment On April 25, 2011, at 6:02 AM, caelin389 wrote:

    It would be nice if once in a while they had a

    "50/50 under $ 10.oo dollars Stock Pick"

    Like after the market fell LVS,was trading at 2.00

    or when Amazon was trading at 2.00 It could be a turnaround story or a new stock.

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