They are two of the most dominant stocks of the past decade. Investments in Amazon (AMZN +1.43%) and Netflix (NFLX +0.27%) have returned 2,500% and 10,600%, respectively, over the past 10 years.
While investors who were insightful enough to buy and hold over that time frame caught lightning in a bottle, investors today are left with a difficult question: Between these two, is either stock worth buying?
Image source: Getty Images.
While the two businesses have some similarities -- both offer streaming video services, for instance -- there are lots of differences. That can make comparing them difficult. To bridge the gap, let's evaluate each on three different facets and see which comes out on top.
Financial fortitude
The first aspect we'll evaluate is financial fortitude. The central question is simple: if an economic crisis were to hit today, what kind of an effect would it have on the company? It doesn't really matter if the crisis is company-specific or macro in nature. A company can have three different designations: fragile, robust, or antifragile.
Remembering that Amazon is valued at over four times the size of Netflix, here's how they stack up:
| Company | Cash | Debt | Free Cash Flow (TTM) |
|---|---|---|---|
| Netflix | $2.6 billion | $6.5 billion | ($1.8 billion) |
| Amazon | $26 billion | $25 billion | $5 billion |
Data source: Yahoo! Finance. Cash includes long and short-term investments. TTM = trailing-12-month.
Netflix has signaled to Wall Street that it will be spending hand over fist on original programming. That, coupled with the company's uber-aggressive international expansion, has not only given it a negative net cash position, but forced it to bleed out almost $2 billion in free cash flow over the past year.
While that move might help secure Netflix's dominance over the long run, it does introduce short-term fragility that investors need to account for.
Amazon, on the other hand, used to have far more cash than debt on hand. The acquisition of Whole Foods, however, changed that. No matter: The company still has a positive net cash position and positive free cash flow.
I'd say that while Amazon is robust to a financial crisis (it would survive largely unscathed), Netflix is fragile to short-term disruption at this point.
Winner = Amazon.
Valuation
It might seem silly to even try to nail this one down. For the entirety of their public lives, both Amazon and Netflix have been panned as far too expensive. That hasn't stopped either from producing eye-popping returns over the long run.
That said, when we consult four popular valuation metrics, here's what they tell us:
| Company | P/E | P/FCF | P/S | PEG Ratio |
|---|---|---|---|---|
| Netflix | 262 | N/A | 14 | 3.0 |
| Amazon | 274 | 169 | 4 | 5.1 |
Data sources: Yahoo! Finance, E*Trade, YCharts. P/E = price to earnings; P/FCF = price to free cash flow; P/S = price to sales; PEG ratio = price/earnings to growth. P/E is calculated using non-GAAP (generally accepted accounting principles) earnings per share when applicable.
These numbers are so high across the board that it's a wild goose chase to say that one company is definitively "cheaper" than another. There are too many moving variables -- and the markets these two are capturing are too large to accurately quantify what they could accomplish -- to make a call here.
Winner = Tie.
Sustainable competitive advantages
Finally, we have the most important variable: the strength of each company's moat.
For a long time, I wasn't particularly impressed with Netflix's moat. People could switch on a moment's notice and cancel their subscriptions. But when I sat down to think about it, I realized something: People join Netflix for the original programming. Once they're in the ecosystem, the meager monthly fee is taken automatically from their credit cards. While switching away is easy, few would even bother to spend the time doing so.
Once I realized this dynamic, it became clear that Netflix's original programming was the real growth hook. The brand is burnished by Orange Is the New Black, House of Cards, and other popular shows. Not only that, there's an underappreciated network effect at play as well: As more subscribers sign on, Netflix has more cash to buy content or develop its own in-house. That leads to more content and more subscribers -- a virtuous cycle.
Normally, that would be more than enough for me to crown Netflix the winner. But Amazon isn't a normal competitor. The company benefits from all four major moats:
- Brand value: According to Forbes, Amazon has the fifth most valuable brand in the world, worth roughly $70 billion.
- Low-cost production: Because of Amazon's network of fulfillment centers, the company can guarantee two-day delivery for a lower internal cost than anyone else.
- Network effects: As more shoppers flock to Amazon.com, third-party vendors list on the site and use Fulfillment by Amazon, drawing in more users.
- High switching costs: While this one is weaker, Amazon Prime subscribers would have a very tough time finding a better deal than the one they currently have.
Add all of those things together and Amazon has an edge here.
Winner = Amazon.
And my winner is...
So there you have it: Amazon wins. While we can throw valuation out the window, Amazon has a stronger balance sheet and a wider moat. That being said, I don't want to throw too much shade on Netflix either. I have bullish CAPS calls on both companies, and own both in my personal portfolio.
That said, Amazon accounts for over 20% of my holdings, while Netflix clocks in at less than 5%. The reasons I'm comfortable with that mismatch are covered above -- a wider moat and stronger balance sheet. Having said that, I think both are worthy of consideration in your portfolio.
