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Investors forgive biotechs for the losses they incur during their drug development and testing phases. They look the other way when a fast-growing dot-com is posting losses as it builds out its platform. So why can't Netflix (Nasdaq: NFLX ) get a similar pass?
Citigroup analyst Mark Mahaney issued a bullish note on the video service earlier this week, arguing that the company trades for just 12 times its domestic business.
Not even bulls argue that Netflix is cheap on a valuation basis. Netflix is expected to post just a marginal profit this year, and it's trading for more than 30 times next year's projected profitability.
The rub, of course, is the streaming giant's costly overseas expansion. The $67 million contribution profit that Netflix generated in its domestic streaming business during the first three months of this year was more than offset by a $103 million shortfall internationally.
However, Mahaney's compelling earnings multiple in the pre-teens removes the sandbag of losses incurred internationally. He's only looking at the company's 23.4 million stateside streaming accounts -- and its even more lucrative 10.1 million disc-based customers -- to arrive at the earnings multiple of 12. In reiterating his bullish call and a juicy price target of $130, Mahaney prefers to see it as a cheap domestic operator with an international appendage being thrown in for free.
Addition by subtraction
Investors make this mistake often. Zipcar (Nasdaq: ZIP ) is also trading at more than 30 times next year's net-income forecast. Does that make the car-sharing service expensive? Well, let's take a closer at this year's freshman quarter. Zipcar generated $6.8 million in pre-tax operating profit during the seasonally sleepy first three months of this year, but the company reported a small loss for the period as deficits internationally and in its younger stateside markets ate into its healthy established markets.
Why are we punishing these companies for reaching higher? If they were to retreat to their flagship businesses -- in Netflix's case it would be domestic and in Zipcar's case it would be the four major metropolitan markets that make up more than half of its business -- both companies would be very profitable.
Mahaney's approach with Netflix, where he sees its cash-slurping international endeavors as a "free call option," makes sense.
Investors need to reward companies for going big and stop discounting the valuations to the point where the profitable operations are too cheap to ignore.
Yes, Netflix is cheap in a way that a simple eyeballing of a forward earnings multiple will never show you.
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