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Better Buy: Disney vs. Netflix

By Will Healy – Aug 12, 2020 at 7:15AM

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Will Disney's stability or Netflix's massive growth win out when it comes to investing options?

Although many streaming companies are operating these days, most investors tend to focus on Netflix (NFLX -2.04%) and, lately, Disney (DIS -0.01%). Netflix pioneered the industry, and as it grew, it placed pressure on Disney's pay-TV offerings as customers increasingly cut the cord. Disney finally responded with streaming services of its own.

Nonetheless, investors should note that the two communications stocks are not an apples-to-apples comparison to one another. Netflix merely offers streaming services, while Disney is a media and entertainment conglomerate.

Still, with both companies heavily involved in both streaming and content creation, they share much in common. They both also stand to benefit from a compound annual growth rate (CAGR) of 20.4% in the global streaming industry through 2027.

However, determining which company might become a more profitable investment takes a greater understanding of the financials and the businesses themselves.

Young woman with headphones watching laptop while eating popcorn.

Image source: Getty Images.

Where Disney stock stands

Disney has been operating as an entertainment company for nearly 100 years. In that time, it has produced and acquired a content library unmatched by any other company.

Lately, Disney's various streaming services have attracted a great deal of interest. Disney+ launched in November 2019 and is already boasting 57.5 million subscribers. ESPN+ subscriptions have more than doubled in the past year, while Hulu subscriptions grew by more than 27% over the last 12 months.

However, this streaming growth does not make Disney a slam-dunk investment. Disney+ makes up a part of its direct-to-consumer and international (DTCI) division, a division of the company that accounted for less than 20% of Disney's overall revenue in the second quarter of 2019. In the most recent quarter, DTCI's share of overall revenue rose to more than one-third.

Still, this is partially due to deep revenue declines in other divisions. Thanks to COVID-19's effects on the parks, experiences, and products and the studio entertainment divisions, overall revenue fell by 42%. This took net income down by 72%, which more than negates the success of Disney+. Year to date, Disney stock has lost 14% of its value.

DIS Chart

DIS data by YCharts

Consequently, Disney trades at a forward price-to-earnings (P/E) ratio of almost 50. This significantly exceeds its average forward multiple of approximately 20.

However, analysts also forecast an 84% earnings increase for next year as Disney hopefully moves past the pandemic. That would give Disney stock a more reasonable valuation and position it to finally benefit from its success in the streaming media space.

Investors and Netflix stock

Streaming success is nothing new to Netflix. It has grown to almost 193 million paid subscribers. This amounts to a growth rate of 27.3% year over year. Though that lags the streaming subscription growth rates seen with both Disney+ or ESPN+, Netflix continues to lead the streaming industry.

The pandemic has turned into a strange but profitable situation for Netflix. COVID-19 has caused an increased demand for streaming media. It has also paused production on many programs. This is significant, as Netflix bore a heavy financial burden in producing its programs. As a result, debt levels climbed significantly higher over the last few years.

For the previous quarter, free cash flow came in at $899 million. This is higher than the net income of $720 million due to non-cash charges. Still, the long-term debt of $15.3 billion has increased by more than $500 million during fiscal 2020.

So far, investors have ignored these troubles. Netflix stock has risen by more than 52% since the beginning of the year.

NFLX Chart

NFLX data by YCharts

Investors will pay a premium for this growth as it trades at just over 80 times forward earnings. Still, the 49.9% earnings growth forecasted for this year should make the multiple more palatable.

The profit increases will probably come at a price. A return to production will likely take the company back to negative free cash flow and higher debt levels. Moreover, rising competition makes a potential price increase riskier.

Netflix serves foreign markets like India that could help continue the rapid growth as the U.S. reaches a saturation point. Nonetheless, if Netflix cannot find a way to remain cash flow positive after the pandemic eases, it could spell trouble for the streaming giant.

Disney or Netflix?

Both stocks should perform well in the near term. Disney's finances will improve once theme parks, cruise ships, and movie theaters can reopen. Moreover, Netflix should continue to thrive with the global streaming media market. 

However, if I have to choose one for the long term, I would pick Disney. Disney runs a more diversified business. More importantly, it owns a more valuable content library. No matter how much damage Netflix inflicts on its balance sheet in the content race, I do not believe it will catch up to Disney.

Although Netflix will likely remain one of the top streaming companies, Disney is in a much stronger position to both survive turmoil and profit from its existing assets.

Will Healy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix and Walt Disney and recommends the following options: long January 2021 $60 calls on Walt Disney and short October 2020 $125 calls on Walt Disney. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Netflix Stock Quote
$285.54 (-2.04%) $-5.96
Walt Disney Stock Quote
Walt Disney
$98.87 (-0.01%) $0.01

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