It's Not Too Late to Buy Netflix

Source: YCharts.

Netflix (NASDAQ: NFLX  ) has delivered mind-blowing returns for investors in recent years, and the stock is clearly priced at demanding valuation levels after such a steep rise. Besides, competition from players like Amazon (NASDAQ: AMZN  ) and Time Warner's (NYSE: TWX  )  HBO is a considerable risk to watch in such a dynamic and changing industry.

But none of this means that the run is over for Netflix. Far from that, the online-streaming leader still offers plenty of upside potential in the years to come.

Source: Netflix.

Competitive risks
Amazon is usually considered the biggest threat for Netflix when it comes to online streaming subscribers. Amazon Prime offers free two-day shipping, access to the Kindle Owners' Lending Library, and more than 40,000 titles available for streaming via its Prime Instant online-video service for a competitive price of  $79 per year.

The service has "tens of millions" of members worldwide, and Amazon even had to limit new membership signups during peak periods in December due to capacity constraints.

Amazon is well-known for its aggressive competitive drive, and the company has deeper pockets than Netflix, but the online-retail giant is investing heavily in different growth areas at the same time, so video streaming is probably considered another way to add value to its customers as opposed to a big business opportunity for Amazon on a stand-alone basis.

Time Warner has recently announced that HBO ended 2013 with approximately 43 million domestic subscribers in the U.S. and nearly 85 million international subscribers. The HBO GO mobile app grew more than 30% during the year, and the service is now available in 23 international markets.

Netflix has always recognized HBO as a major competitor, not only because of its presence among customers, but also due to its strength when it comes to content and original programming. HBO is entering 2014 with returning hits like Game of Thrones, Boardwalk Empire, True Blood, and Girls, in addition to five new series, including the already successful True Detective.

Source: Netflix.

Content is king
Competition is always a risk to watch, especially in such a growth business. But investors need to consider that online video streaming won't necessarily be a zero-sum game in which only one company wins and the other ones go down.

The media and entertainment industry has always generated enough opportunities for multiple players to profit and grow over time, and there is no reason to believe streaming will be much different.

Besides, Netflix is building its competitive strengths and differentiation on the basis of providing valuable content for a convenient price, quite a simple and effective proposition for customers.

Looking at productions like House of Cards in terms of financial costs versus incremental subscribers is far too shortsighted: Netflix is playing this game for the long term, and the key is creating a library of unique content to capitalize the enormous room for growth offered in online streaming over the coming years. From that perspective, Netflix's venture into original content has been spectacularly successful.

Netflix has been growing at full speed in spite of increased competitive pressure over the last several years; the company added 2.33 million subscribers in the U.S. and 1.74 million international subscribers during the fourth quarter of 2013, ending the year with 33.42 million domestic and 10.93 million international subscribers.

Investors need to monitor the competitive dynamics in the business, but Netflix is stronger than ever in terms of content and differentiation, so the company has the strength to continue thriving in the face of increasing competition.

Source: Netflix.

The price of growth
Netflix trades at an aggressively high forward P/E ratio of almost 60 times earnings estimates for 2015. This is certainly a demanding valuation that incorporates high growth expectations, but the company has what it takes to grow into its valuation.

Sales have been booming lately, and profit margins are on the rise over the last several quarters as revenues are outgrowing content costs. Management expects to reach its goal of a 30% contribution margin in the U.S. by 2015, and the combination of growing sales and increasing profit margins could provide a double boost to earnings growth in the years ahead.

The company is doing remarkably well in the U.S., and international markets still offer enormous room for expansion. This growth story is far from over, and valuation is no reason to avoid Netflix from the perspective of a long-term investor.

Bottom line
Operating in a highly dynamic industry and trading at aggressive valuation levels, Netflix is clearly an investment with above-average risk. But the company has the competitive strength and the market opportunity to continue delivering outstanding growth rates for investors over years to come. This exciting movie is just getting started.

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Read/Post Comments (2) | Recommend This Article (5)

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  • Report this Comment On March 12, 2014, at 9:05 AM, Fo45 wrote:

    There is a number of unanswered questions regarding Netflix . The company is illusive about expenses. Sells $20 bill for $19 amortizes payment without telling us how by employing sophisticated accounting technics. The price of content is skyrocketing, the price of content delivery as well, Netflix is not increasing membership prices and has to spend money to expand in a not English speaking, highly regulated and risky international market. Furthermore, Netflix is very subscriber number sensitive. Competition is fierce and originals are not netflix's original anymore( available to Comcast members ) subsequently affecting Netflix's growth. So, I would ask investor to be cautious and think clearly not to give up to the euphoria not to gamble.

  • Report this Comment On March 12, 2014, at 5:42 PM, pauldeba wrote:

    "amortizes payment without telling us how by employing sophisticated accounting technics. "

    No, they do it straight line over the life of the contract, specifically identifying where they can. if it is a package, all gets allocated the same way. I am not saying it is right and there is no impaired content, but the accounting is crystal clear, they even had a link on their investor website explaining it all 2 years ago, maybe it's still there.

    Netflix has a decent product at a low price, they will never earn great profits because they don't want to and attract all the competition that will kill it. They are a bit like the minor league pitcher that strikes everyone out but knows he can't make it in the big leagues, they are fine where they are, no need to step up and fail. Of course, Wall street bozos and the author think they are the second coming of Cy Young.

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Andrés Cardenal

Andres Cardenal, CFA is a tenacious researcher of the best investment opportunities around the world. Andres is an economist and CFA Charterholder living in Buenos Aires, Argentina. Naturally flavored. Follow me on Twitter for more investment ideas:

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9/3/2015 4:00 PM
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