Why Long-Term Investors Should Prefer Amazon.com Over Netflix Inc.

Amazon (AMZN -0.16%) and Netflix (NFLX 1.71%) account for half of the "FANG" quartet of high-growth tech stocks. Amazon is the dominant name in both Internet retail and cloud infrastructure, while Netflix rules the video streaming market with 81.5 million subscribers worldwide.

Image source: Netflix.

But over the past few years, Amazon has aggressively expanded into the streaming video market to challenge Netflix. In 2011, it gave its Prime members access to thousands of streaming videos from its Instant Video library. The following year, Amazon inked a distribution deal with Epix (previously Netflix's exclusive partner) to expand its media library. It started producing original shows and films in 2013, and introduced a YouTube-like service for users to share videos earlier this year. Amazon also recently launched a stand-alone Amazon Video option for $9 per month to undercut Netflix's $15 monthly fee.

This rapid escalation of hostilities puts Netflix -- which is already engaged in constant battles with content providers and carriers -- in a tough spot. It also arguably makes Amazon a better long-term investment than Netflix for three simple reasons.

Amazon has a much wider moat

For Amazon, streaming video is just another perk for its Prime members, who pay $99 per year for discounts, free shipping options, free e-books from the lending library, cloud storage, and other perks. Expanding its Prime ecosystem is a top priority for Amazon, because those customers generally pay more and buy fewer products from rival e-commerce sites.

Image source: Amazon.

Back in January, research firm CIRP reported that the average Prime member spent $1,100 per year on the site, compared to just $600 for non-members. It also reported that the number of U.S. Prime members grew 35% year-over-year to 54 million. Therefore, Amazon can likely afford to break even or take losses on Amazon Video as long as it drives growth in Prime members, who buy more products from its core marketplace business. Amazon's marketplace still runs on thin margins, but its high-margin cloud platform AWS (Amazon Web Services) business now generates over half of its operating profits.

But streaming video is Netflix's bread and butter, and its margins are already thin. Its total operating margin was just 2.5% last quarter, down from 6.2% a year earlier. That figure is expected to slide to 2.2% during the current quarter, due to the high costs of content acquisition, original content production, marketing campaigns, and overseas expansions. If Netflix lowers its subscription fees to compete against Amazon and other streaming rivals, its operating margins could easily turn negative.

Netflix relies on too many companies

Netflix has aggressively expanded its slate of original shows and movies, but streaming content obligations (the amount it promises to pay studios to license future titles) are still its biggest expense. That total rose 26% annually to $12.3 billion last quarter, indicating that it won't declare independence from big media companies anytime soon.

Some Netflix bulls point to its multi-year distribution deal with Disney (DIS 0.82%) as a strong catalyst for future subscriber growth. But Netflix is also reportedly paying Disney more than $300 million per year for that privilege. Several of Netflix's most popular programs are Marvel shows that it co-developed with Disney's ABC Studios. This lopsided relationship gives Disney lots of leverage to renegotiate higher rates after the current deal expires. That's the same reason Netflix eventually cut ties with Starz (STRZA) and Epix.

Netflix, Amazon, and other OTT (over-the-top) providers pay telecom companies for "paid peering" connections which are essential for high-quality streams. Meanwhile, telcos are launching their own data-free video streaming services in a bid to disrupt Netflix's business on mobile devices. This conflict of interest gives telcos leverage to raise paid peering rates on OTT providers, which could hurt Netflix's margins. Netflix is also heavily dependent on Amazon, since its entire streaming video library is hosted on AWS. This means that Netflix actually funds Amazon's most profitable business, which ironically bolsters its rival's ability to charge lower prices for Amazon Video.

Amazon is still the cheaper stock

Amazon and Netflix are often called "cult stocks" which seemingly defy fundamental gravity, but the former is still cheaper than the latter:

Data source: Yahoo Finance, as of June 7.

With lower multiples across the board and a more diversified business model, Amazon looks like a much safer long-term investment than Netflix. The key takeaway is simple -- streaming video represents just one extension of Amazon's ecosystem, but it's Netflix's entire business. The market for streaming video is an increasingly competitive one, so a company like Amazon -- which doesn't have all its eggs in one basket -- should fare much better than a top-heavy player like Netflix in the long run.