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Forget Activision Blizzard: Netflix Is a Better Entertainment Stock

By Anders Bylund – Jun 10, 2020 at 8:09AM

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Both of these companies benefit from the COVID-19 crisis, but one is a far stronger long-term investment than the other.

Video game developer and publisher Activision Blizzard (ATVI 0.27%) is doing well in the time of coronavirus stay-at-home orders. The company crushed Wall Street's expectations in last month's first-quarter earnings report, and management gave credit for the outperformance to the COVID-19 dynamics and a strong portfolio of new content. This trajectory is hardly unique in the video game sector, but Activision is a proven leader in that thriving market.

All of that being said, I would still rather buy Netflix (NFLX -1.37%) shares over Activision's today.

1,000 words

A simple picture can speak volumes:

NFLX Revenue (TTM) Chart

Data source: YCharts.

Netflix more than doubled its revenue over the past three years while Activision's annual sales dropped 7%. The video-streaming leader's earnings grew sixfold and the video game maven's bottom line increased by 41%. For Netflix, its earnings before interest, taxes, depreciation, and amortization (EBITDA) kept pace with the company's revenue growth. Activision's EBITDA fell by 19%.

If Netflix's higher-octane growth didn't impress you, maybe the scale of the financial performances did. Was it news to you that Netflix's annual sales are more than three times the size of Activision's? Or that Netflix is posting 39% higher adjusted net income figures? I'm pretty sure you hadn't seen the digital video veteran's EBITDA profits coming in at nearly six times Activision's results.

A red Netflix sign on a beige wall.

Image source: Netflix.

All the right profits

Netflix isn't exactly known for its profitability. Critics like to point out that its free cash flows are printed in red ink and that management expects them to stay below the breakeven line for another couple of years.

I'm highlighting Netflix's EBITDA profits for a reason. This is the profit metric that banks like to use when measuring a company's financial risk and its ability to repay debts. Credit rating specialist Moody's upgraded Netflix's corporate credit rating in 2018 and might soon do so again -- the firm placed Netflix on a positive outlook level in April.

"Moody's would consider upgrading Netflix's ratings if the company can sustain debt-to-EBITDA leverage below 4.0x (including Moody's adjustments)," the rating firm wrote. "Positive free cash is highly likely within a two-year forward period, margins and subscriber counts continue to expand and liquidity remains very good."

Let me repeat that. Positive free cash is highly likely within a two-year forward period, says the credit rating specialist. Banks will base their loan terms on that analysis, and it all comes back to that rising EBITDA line. It's a shame that many investors are ignoring this important metric.

A golden chess knight stands surrounded by several prone silver pieces.

Image source: Getty Images.

Forget Activision

Netflix is building an exciting growth business for the ages here. Activision is struggling to deliver even a modest level of sustainable revenue growth, and its profits jump or fall with the release of hit games or failed swings.

Sure, Netflix shares look more expensive than Activision's. Netflix is trading at 90 times trailing earnings and 49 times forward estimates, compared with 35 times trailing earnings and 23 times estimates for the video game giant. But you get what you pay for. Netflix earned those higher valuations in the three long-term growth charts above.

Anders Bylund owns shares of Netflix. The Motley Fool owns shares of and recommends Activision Blizzard and Netflix and recommends the following options: long January 2022 $75 calls on Activision Blizzard and short January 2022 $75 puts on Activision Blizzard. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Netflix, Inc. Stock Quote
Netflix, Inc.
$221.01 (-1.37%) $-3.06
Activision Blizzard, Inc. Stock Quote
Activision Blizzard, Inc.
$74.53 (0.27%) $0.20

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