Netflix (NFLX -3.92%) and Alphabet (GOOG 0.74%) (GOOGL 0.55%), the parent company of Google, both belong to the "FAANG" cohort of top U.S. tech companies, alongside Facebook, Apple, and Amazon. Like those other companies, Netflix and Alphabet disrupted older markets and changed people's habits.
Netflix disrupted the video rental and pay TV markets by transforming its mail-based DVD rental service into a streaming platform. Google's core platform become synonymous with online searches, while products like YouTube, Gmail, Android, and Chrome all dominated their respective markets.
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Over the past five years, Netflix's stock has rallied nearly 400% as Alphabet's stock has risen over 130%. Let's see why the former outperformed the latter by such a wide margin, and whether or not that trend will continue.
How do Netflix and Alphabet make money?
Netflix generates all its revenue from monthly subscription fees, which vary based on the maximum resolutions and number of devices. The service is currently available in over 190 countries, and Netflix licenses and produces a wide range of localized content for overseas markets.
Alphabet generated 83% of its revenue from Google's core advertising business last year. Nearly 6% came from Google Cloud, while the remaining 11% came from "other" Google products -- including its hardware devices and YouTube's subscription revenue.
How fast is Netflix growing?
Netflix's revenue rose 31% in 2019, and grew another 26% year-over-year to $11.9 billion in the first half of 2020. Its total paid subscribers worldwide increased 23% year-over-year to 192.95 million in the first half, which indicated it wasn't ceding the market to new challengers like Disney+.
Netflix's net income grew 54% in 2019 and surged 133% year-over-year to $1.43 billion in the first half of 2020. Netflix attributed that robust earnings growth to its rising subscription revenue, reduced operating expenses, and postponed spending throughout the COVID-19 crisis.
The COVID-19 crisis didn't meaningfully disrupt the production of Netflix's original content, and actually buoyed its subscription and engagement rates as more people stayed at home. Netflix expects its revenue to rise 21% year-over-year in the third quarter, its paid subscribers to increase 23%, and its net income to jump 43%.
For the full year, Wall Street expects Netflix's revenue and earnings to rise 23% and 50%, respectively -- which indicates the stock remains reasonably valued at about 55 times forward earnings. Analysts expect that momentum to continue next year with 17% revenue growth and 42% earnings growth.
How fast is Alphabet growing?
Alphabet's revenue rose 18% in 2019, but grew just 6% year-over-year to $79.5 billion in the first half of 2020 as sales of Google's ads decelerated throughout the pandemic. The growth of Google Cloud and Google's "other" businesses partly offset that deceleration, but those business generate much lower-margin revenue than its core advertising business.
Image source: Getty Images.
Alphabet's net income grew 12% in 2019, but declined 17% year-over-year to $13.8 billion in the first half of 2020 due to the loss of its higher-margin ad revenue, higher operating expenses related to COVID-19 safety measures, and YouTube's ongoing expansion.
Analysts expect Alphabet's revenue to rise 7% for the full year, but for its earnings to decline 10%. Alphabet's stock might not seem cheap at about 25 times forward earnings, but analysts expect its revenue and earnings to rise 21% and 28%, respectively, next year, as the pandemic passes and its ad business recovers.
That outlook is encouraging, but investors should note that Alphabet still faces unresolved antitrust cases across the world regarding its dominance of online searches and advertising. Netflix doesn't face any similar threats.
The winner: Netflix
Netflix and Alphabet are both solid long-term investments, but Netflix is a more compelling buy right now. It's generating stronger revenue and earnings growth, it's better insulated from the COVID-19 crisis, and it isn't being probed by antitrust regulators. Netflix's stock isn't cheap, but its strengths arguably justify its premium.
