A Good Sign for Netflix Bulls

Netflix is trading at 245 times earnings, which keeps some investors on the sidelines. This is understandable. However, if you ignore valuation and focus on the underlying business and future growth opportunities, Netflix is still impressive.

Mar 13, 2014 at 1:00PM

Netflix

netflix.com

Mintel (a firm specializing in market research, trends, and insights) recently conducted a study on streaming video popularity and growth. You might think that streaming video is well into its growth stage, but that would be a massive misconception. Mintel's results indicate that streaming video is still in its early growth stages, which is excellent news for Netflix (NASDAQ:NFLX).

Inspiring numbers
Mintel discovered that 46% of people living in the United States used a subscription video account over the past month. That's not the most important number, though. The most important consumer demographic is the millennials, and according to Mintel, 71% of consumers between the ages of 18 and 34 took advantage of a subscription video account over the past month.

If 71% of the 18-34 age demographic are taking advantage of subscription video services, then not only is it likely that they will continue to use this service in the future due to industry trends and convenience, but it's also likely that the generation behind them will follow a similar course. This, of course, would benefit Netflix, which is currently found in approximately 25% of U.S. households.

Between 2011 and 2013, online streaming video sales increased 25%, and Mintel expects total sales to reach $16.7 billion by 2018.  

Since trends favor streaming video, you might assume that Amazon.com (NASDAQ:AMZN) and Hulu also stand to benefit. You're likely only half right.

An uneven playing field
According to a Mintel poll, 76% of consumers would rather pay for content than be interrupted by commercials while watching free content. While Hulu offers Hulu Plus, most people go to Hulu for its free content. Therefore, trends aren't as likely to favor Hulu as much as Netflix and Amazon Prime Instant Video.

If you're not a believer in this theory, consider recent online traffic comparisons for Netflix and Hulu over the past three months. According to Alexa (an online global analytics company), Hulu.com's pageviews-per-user has declined 2.75% to 4.95, time-on-site has slid 3% to 5:24, and bounce rate (where visitors views one page and leaves) has increased 2% to 35%.

While none of the above numbers are terrible, they're not uplifting, either. They could also be seen as subpar given strong industry trends. It looks as though Disney, 21st Century Fox, and Comcast's NBCUniversal may have made rare missteps when they had the opportunity to sell Hulu to DirecTV last summer for $1 billion.

These three companies invested $750 million to grow Hulu through content acquisition, program development, marketing, and technology. Perhaps it's still early, but the simple fact is that the Hulu brand doesn't hold a candle to Netflix in consumers' eyes.

Getting back to online traffic, over the past three months, Netflix saw pageviews-per-user grow 2.90% to 5:33, time-on-site improve 4% to 6:10, and bounce rate remain unchanged. Even if you attempt to make the argument that three months isn't a large enough sampling, consider Netflix's overall better performance in pageviews-per-user and dominance in time-on-site.

Original content
Netflix currently has 20 original shows, and it has 11 more in the works. Netflix's experience with original shows gives it a significant edge over Amazon Prime Instant Video, which just began airing original content last fall. As far as Hulu goes, it had 20 new shows in 2013, and there 40 new shows in development. However, there is no House of Cards or Orange is the new Black on Hulu.

It's somewhat surprising that Amazon was so late to the party with original content. It's possible that it wanted to see how Netflix would perform before getting involved. While Amazon has many different segments to commit to, its significant cash-flow generation -- $5.48 billion over the past twelve months – always makes it a threat.

Netflix only generated $97.83 million in operating cash flow over the past year. It will also be spending $3 billion in television and film content in 2014, as well as $6 billion over the next three years. On the other hand, fiscal-year 2013 revenue increased 19% year over year, whereas the cost of that revenue increased just 17%. 

The Foolish takeaway
Streaming video is still on the rise, and Netflix is the biggest player in the game. Its original content has played a big role, and based on past successes, the company is likely to continue seeking growth in this area without going overboard in regard to cost. Since Netflix is trading at 245 times earnings, risks exist, but if you ignore valuation and focus on the underlying business, then Netflix is a winner. Please do your own research prior to making any investment decisions. 

What other companies stand to benefit for changing content trends? 
You know cable's going away. But do you know how to profit? There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. Hint: They're not Netflix, Google, and Apple.

  

Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Netflix. The Motley Fool owns shares of Amazon.com and Netflix. 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. The Motley Fool has a disclosure policy.

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