In the age of low interest rates and technological change, disruptive growth stocks have reigned supreme. Two of the best-performing tech market leaders in the past few years have been Amazon (NASDAQ:AMZN) and Netflix (NASDAQ:NFLX). As you can see, both stocks have absolutely trounced the broader market, nearly quadrupling over the past five years, versus just a 66% gain for the S&P 500.
If you're thinking of putting new investment dollars behind one of these two leaders, you might think that you've missed the boat. But remember, you could have also said that four years ago...or three years ago...or two years ago...or last year. In general, high-quality companies with excellent products and managements keep on winning, so let's investigate which of these two stocks is the better bet today.
The case for Netflix
Netflix is far and away the leader in over-the-top streaming television. In fact, Netflix pioneered the streaming revolution. Though it began as a mail-order DVD subscription service in 1997, CEO Reed Hastings saw the future of internet television early on -- certainly earlier than legacy network and cable television companies that were quite comfortable with the traditional cable model.
Netflix began its streaming service in 2007 -- the same year that the iPhone came out. At first, the offering was mostly second-rate films and television shows, but Netflix gradually improved the service every year as it gained more and more subscribers.
2013 marked a pivotal year, when Netflix released its first large-scale original series, House of Cards starring Kevin Spacey. After analyzing data showing that a large number of people who liked Kevin Spacey movies also enjoyed the original British House of Cards, Netflix put a big budget and major film director David Fincher behind the new venture.
The data-plus-hiring-top-talent recipe worked like a charm, and Netflix hasn't looked back since. Every year, Netflix ramped up its original content spending, piling up subscribers and attracting top talent. Netflix was also a visionary in terms of targeting international markets, which now make up a majority of its subscriber base. As of last quarter, Netflix had amassed 149 million global streaming subscribers -- good for a stunning 25.2% year-over-year growth, even though Netflix is already the largest global streaming service. Not only has Netflix been able to grow subscribers, but it has also raised prices several times in the past few years without very much in the way of churn. That shows tremendous pricing power.
Some reasons for caution
Though Netflix has a tremendous lead in subscribers, it has poured basically all of that subscriber revenue into more and more content and marketing. Though the company has been posting profits on a generally accepted accounting principles (GAAP) basis, Netflix has also spent far more on new self-funded original series. Last quarter, management revealed that it will now have negative $3.5 billion in free cash flow in 2019, revised upward from its negative $3 billion target at the start of the year. Just recently, The Information reported that Netflix content head Ted Sarandos told several company executives that Netflix will need to become more efficient with its content spending going forward.
Competition is also coming online soon. After a slew of industry mergers, large media companies have gotten their acts together on streaming and are just now beginning to launch their own services -- often taking content they previously sold to Netflix with them.
For instance, Netflix has been able to stream Disney (NYSE:DIS) movies over the past few years, but Disney didn't renew that deal, instead opting to launch its own Disney+ streaming service, coming in November for just $6.99 per month -- nearly half the price of Netflix. Disney is also now in control of Hulu and thus may be able to bundle both services to attract a broader streaming customer base.
Word on the street is that AT&T (NYSE:T), which bought Time Warner in 2018, will be launching its own WarnerMedia streaming service next year. NBC parent Comcast (NASDAQ:CMCSA) will also be launching its own streaming service soon and is taking important content with it, including The Office, which has been one of the most-binged shows on Netflix. Comcast will take back The Office in 2021, when its streaming offering should be up and running.
However, the market doesn't appear to be too worried about these competitive threats at the moment. Netflix is currently valued at $166 billion, and the stock trades for a lofty 135 PE ratio and a whopping 65 times next year's earnings.
The case for Amazon
Most people are very aware of Amazon, though you might not be aware of just how deep Amazon's reach is. Founded in 1994 by visionary leader Jeff Bezos, Amazon began as an online bookseller, one of the first businesses to sell goods via a new invention called "the internet." Since then, Amazon has expanded to selling just about everything under the sun via its website and leading end-to-end delivery network, which uses the USPS and private carriers, as well as Amazon's in-house planes, ships, and last-mile resources.
In 2005, the company unveiled Amazon Prime, a low-cost subscription that guaranteed two-day shipping on a number of items. Prime began at $79 per year, but Amazon kept adding more and more features to Prime, including Amazon's own streaming video service (to rival Netflix), discounts on Whole Foods, which Amazon acquired in 2017, music streaming, photo sharing, a Prime-only credit card with generous benefits, and one-day shipping on select items, among others. Just recently, Amazon announced it would be upgrading Prime to one-day shipping, once again keeping the Seattle juggernaut one step ahead of rivals. Since launch, Amazon Prime has surged to more than 100 million subscribers, even as the company raised the price of Prime several times to the current $119 per year.
But Amazon's single best business might be Amazon Web Services. Though the seeds of this business go back to 2000, Amazon eventually built out a massive and highly efficient computing and database platform to rent to outside developers for a low fee. After a few years quietly building out the platform, Amazon launched Amazon Elastic Compute Cloud in August 2006. With a clear first-mover advantage, Amazon has grown AWS into a massive $30 billion run-rate business, growing at 42% (FX-neutral), and with fat operating margins of 29%.
Finally, Amazon also has a few highly profitable newer businesses, such as its third-party fulfillment services and its fast-growing online advertising business. Most recently, Amazon unveiled Shipping by Amazon, opening up its logistics network to send and deliver packages, and bought online pharmacy PillPack in 2018, making a bigger entry into the online healthcare and pharmacy field.
While Amazon, like Netflix, spent many years being cash flow negative, Amazon's profitability has taken off recently, with free cash flow of $23 billion over the past 12 months, nearly triple the amount from a year prior.
In fact, Amazon's biggest risk may be its own success. Recently, the Federal Trade Commission launched an investigation into Amazon's potential status as a monopoly (along with several other large internet platforms, in partnership with the Department of Justice).
I'd still take Amazon
Of these two leading companies, I'd favor Amazon over Netflix today, mainly due to the lower risk of having a much more diversified business. Netflix may end up being a fine investment from here, but a lack of free cash flow, improving competition, and a higher valuation make Netflix's future success much more of a question mark than Amazon's. In fact, Netflix is not just a competitor but also a vendor of Amazon, as Netflix uses Amazon Web Services for its back-end IT infrastructure. That certainly tells investors something about Amazon's dominance in the cloud and beyond, and that's why I'm sticking with Amazon over Netflix.