Think the Bubble's Bursting on Amazon and Netflix? Think Again

Netflix  (NASDAQ: NFLX  ) and Amazon.com (NASDAQ: AMZN  ) are both love-it-or-hate-it stocks for many people. There's no denying the explosive growth that these two companies have seen over the past decade-plus, as they've revolutionized their industries and disrupted competitors along the way. At the same time, investors who bought into the story have made a fortune. Just as many chose not to invest in either of these "overpriced" investments, and have long railed against the market's overly rich valuing of these two companies. Mr. Market has changed his tune of late, punishing both stocks:

NFLX Chart

NFLX data by YCharts.

As you can see, both stocks are almost 30% (or more) off all-time highs, and the fall has been fast and recent. Has Mr. Market finally realized that these two stocks are just way too pricey for what the companies deliver? Are the naysayers finally being proved right, or is the market giving investors a chance to buy -- if not on the cheap, then maybe for a discount from the usual premium? Let's take a closer look.

Growth story coming to an end?
There's no denying how much these two companies have changed the way consumers buy stuff, whether it's physical goods or how we choose to access TV programming:

NFLX Revenue (TTM) Chart

NFLX Revenue (TTM) data by YCharts.

Both have grown revenues more than 1,100% over the past decade, a remarkable feat considering the compounded average growth rate the two have achieved over that period. Are the fast growth days coming to an end? There's little reason to expect the growth to stop anytime soon:

NFLX Revenue (TTM) Chart

NFLX Revenue (TTM) data by YCharts.

More than 100% growth from 2010 to 2013 -- that's pretty strong. Even over the past year, both saw sales increase more than 20%. 

What about profits?
The main thing Amazon's detractors have pointed to is the company's apparent inability to turn all that revenue growth into profits:

NFLX Net Income (TTM) Chart

NFLX Net Income (TTM) data by YCharts.

Netflix, however, has done a remarkable job of growing earnings as it has expanded (and even reinvented) its business. Truthfully, this measure (net income) isn't necessarily the right one to use to measure either of these two companies -- especially Amazon. 

Amazon, while being a Web-based business, isn't really a Web-based business. Simply put, the company must operate and maintain physical properties -- and staff -- to warehouse and ship the goods that it sells. While not operating a retail footprint does give it a ton of operational and cost efficiencies versus its traditional retail competitors, it doesn't make Amazon immune from the real expense and time it takes to to expand physical capacity. It's been said ad nauseum, but the company really is plowing excess capital from sales back into the business. 

Netflix, on the other hand, faces a different series of challenges to grow. Historically, Netflix and Amazon were great comparables, as Netflix also relied on physical distribution of DVDs to meet customer demand. However, the past several years have seen this portion of the business grow significantly smaller, while streaming has become dominant. 

Netflix is largely dependent on the network effect, as the more people subscribe, the more cash Netflix has to invest in content. The argument from detractors is that Netflix will eventually not be able to both afford great content and keep subscription prices low. However, Netflix's expansion into exclusive content, as well as a history of making deals for content from studios such as Disney have proved again and again, that there's just no evidence that the company is going to get caught in some kind of "hamster wheel of doom."

More subscribers mean more money, which leads to more quality content. Content makers want large audience exposure to their content, both because they can charge more for it and because it will lead to more exposure and demand for new features down the road. It really is the "virtuous cycle" that Netflix management calls it. 

Still growing, still building the businesses
Step outside the stocks for a moment, and consider the size of both of these companies against the addressable market.  For a little perspective, consider that Amazon's revenue was $74 billion last year. If Amazon is the "everything store," and Wal-Mart's total sales last year was $476 billion, does it really sound as if the growth story is coming to an end? For Netflix, total revenue was $4.4 billion, and the company is very early in its international expansion. To date, Netflix has just under 50 million total subscribers worldwide. Of that total, only about 13 million are outside the United States, and that number has doubled from where it was one year ago. 

So... no bubble?
The reality is, both Netflix and Amazon have seen their stock prices move up and down by more than 20% within a few months more than a dozen times in the past decade. It's the reality of what happens with these two still-growing, and highly valued, companies. While I'm not willing to project when we will see them rebound, I'll go on the record saying that it most definitely will happen. That's because the businesses keep growing, and keep performing. And the market has historically been willing to pay for that. 

If you're not willing to pay the market premium for these transformational companies, that's fine; just don't expect either stock to fall in line with what traditional valuation metrics say they're worth anytime soon. But if you're willing to ride out the volatility, these are two still-growing, worthy, long-term investments. 

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Read/Post Comments (6) | Recommend This Article (5)

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 29, 2014, at 7:05 PM, larryw101 wrote:

    I dare you to go long. The bubble has already started to lose air.

    Another worthless Motley article by a nobody author.

  • Report this Comment On April 29, 2014, at 8:56 PM, TMFVelvetHammer wrote:

    >>I dare you to go long. The bubble has already started to lose air.<<

    If you'll look just above the comments, you'll see the disclosure, which clearly states that I am indeed long in both Amazon and Netflix.

    >>Another worthless Motley article by a nobody author.<<

    Since this is from an anonymous commenter, I won't take offense. I hope you don't mind.

    ;)

  • Report this Comment On April 30, 2014, at 3:30 AM, Interventizio wrote:

    Good article. I've added NFLX to my watching list.

    To the author of this article: don't bother answering this larryw101. He's ubiquitous and he's obviously sent by somebody to criticize (for wont of a worse word) Fool's articles.

  • Report this Comment On April 30, 2014, at 3:31 AM, Interventizio wrote:

    Good article, I've added NFLX to my watchlist.

    Note to the author: don't bother answering to larryw101. He's ubiquitous and he's obviously sent by somebody to criticize (just to use a polite word) Fool's articles.

  • Report this Comment On April 30, 2014, at 11:47 AM, margiecfl wrote:

    A virtuous cycle? You do understand that as Netflix gets more subscribers, content producers raise prices and squeeze the profit for themselves. With all the content buyers out there, it will be awhile before content prices settle down due to demand. Til then it will be a rocky ride ...

    http://obvious-stock-picks.blogspot.com/2014/04/netflix-stoc...

    more on that here.

  • Report this Comment On April 30, 2014, at 2:41 PM, TMFVelvetHammer wrote:

    Margiecfl,

    Your arguments are exactly the same ones that have been used for years with regards to Netflix.

    What you are ignoring is:

    1) Netflix and its competitors haven't shown any indication that they will "overpay" for content. Netflix knows what content is worth to it, and remains disciplined in paying rates that are fair and profitable for both parties. You think the Disney deal reflects otherwise?

    2) Just a couple of years ago the DVD profit contribution was almost 90%. It's less than half now. It will continue to decline, but as much because of the growth of streaming's profits as the slow death of physical disk demand.

    Your model is essentially based on valuation and unrealistic competitive changes to the landscape, and doesn't reflect anything new or unique.

    -jh

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