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Here's Why Value Investors Will Miss Out on Netflix Again

By Neil Patel – Nov 5, 2020 at 8:10AM

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If you want huge potential profits from this streaming entertainment behemoth, then avoid traditional quantitative stock screeners.

The never-ending debate rages on.

On one side, there are value investors, who seek out companies selling for a low multiple relative to sales, earnings, or book value. On the other side, we have growth investors, who want to own companies that exhibit high revenue and profit growth.

Wall Street loves putting different investing approaches into specific style boxes, mainly as a way to sell services to clients. However, value versus growth is irrelevant: I think it's the wrong way to approach stock market investing.

The perfect example

Classic value investors can overlook attractive opportunities simply because a stock looks rich (based on a high P/S, P/E, or P/B ratio). Yet some seemingly expensive stocks still may be selling at a discount relative to their long-term potential. A great example of a stock that historically fit this description is Netflix (NFLX -1.74%). On Dec. 31, 2010, the company's market capitalization was $9.2 billion, and profit that year totaled $160.9 million. This means Netflix was trading at a price-to-earnings ratio of 57.

left hand holding remote watching streaming TV

Image source: Getty Images.

If you were a value investor who employed quantitative screening tools to search for cheap stocks, Netflix clearly would not have been on your radar. At its late-2010 trading price, the stock looked way too expensive. Based on how quickly the company was boosting sales and profit, it would have been classified as a growth stock, instead.

Jump ahead almost 10 years, and let's see what happened. From Dec. 31, 2010 to Nov. 3, 2020, Netflix stock soared more than 1,800%. What was seemingly an overpriced security was just the opposite: Netflix was undervalued back then, as it significantly outperformed the S&P 500 in the following years.

Intrinsic value matters

Nearly 10 years ago, Netflix could have accurately been categorized as a growth stock that was a bargain relative to its intrinsic value.

Intrinsic value has nothing to do with earnings multiples, but instead attempts to calculate the true worth of an asset by estimating future cash flows. This requires a much more thorough understanding of a business than simply analyzing and comparing ratios among various companies. And it's precisely why value investors missed out on Netflix. The burgeoning nature of the business made it extremely difficult to project its future earnings with any level of certainty.

Today, Netflix stock trades at a P/E ratio of 78, which is even higher than it was a decade ago. Again, value investors won't be interested because it looks expensive. Yet this is an overly simplistic way of viewing things. Even with a current market cap of $220 billion, Netflix is undervalued, in my opinion.

The company pioneered the streaming entertainment category and invested heavily in its technological capabilities even before cord-cutting was a widely-used industry term. Once a DVD-by-mail service that competed primarily with Blockbuster, Netflix has since developed into a global media company with 195 million subscribers in over 190 countries.

A buying opportunity

Netflix's revenue continues marching higher at a rapid pace year after year, as new and existing subscribers seem unfazed by periodic price increases. The business is in a unique position to capture a larger worldwide audience because of its ever-expanding expertise in content production and its ability to scale extremely well.

For a stock that always appears to be hitting new highs, a drop of 10% since Oct. 13 provides a very attractive buying opportunity. Wasting your time with the value-versus-growth debate is futile. Netflix is a truly outstanding company whose stock currently offers both growth and value for long-term investors. Don't miss out on another decade of outperformance.

Neil Patel has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.

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