Amazon (AMZN -1.65%) and Netflix (NFLX 1.74%) have produced huge stock gains for years, and 2020 has been no exception. The online retail behemoth is up by 76% year to date, and the video streaming leader is up by 52%. For comparison, the S&P 500's total return (including dividends) through Nov. 4 was 8.2%.
It would be easy to attribute the tech companies' gains to the impact of the COVID-19 pandemic. After all, when people were sheltering at home, they were delivering valuable services for a shaken world. But that explanation sells them short. Both disrupted their industries long before 2020 disrupted lives, and they were well-positioned because of years of innovation guided by their founder leaders.
Netflix and Amazon have produced strong gains for investors for years. Image source: Getty Images.
But if you could only invest in one of these growth stock heavyweights now, which would be the better pick?
Leadership
If there was a hall of fame for CEOs, Amazon's Jeff Bezos and Netflix's Reed Hastings would be in it.
Amazon has gone from "Earth's biggest bookstore" to selling virtually everything -- and the company's most profitable division isn't even e-commerce. It's web services. The company's growth has been staggering. In 1999, Amazon had $1.64 billion in total sales. By 2019, annual sales were $280.5 billion -- a compound annual growth rate of 29%.
Then there's Netflix. In 2007, Hastings pushed it into the streaming video business, which risked disrupting a DVD-rental-by-mail service that had 6.3 million subscribers at the end of 2006. It did disrupt that legacy operation -- but it also worked. Now, Netflix is approaching 200 million subscribers. Since Netflix went public in 2002, its annual revenue has grown from $1.34 billion to $20.1 billion in 2019 -- a compound annual growth rate of 17%.
The interests of Bezos and Hastings are aligned with those of their shareholders through stock ownership. Although Bezos has been selling recently, he still owns about $173 billion worth of Amazon shares. Hastings owns about $2.5 billion worth of Netflix shares.
Advantage: Even
Recent performance
Both companies recently issued strong third-quarter earnings reports. Here's how they fared in some key metrics:
|
Q3'20 Metric |
Amazon |
Netflix |
|---|---|---|
|
Revenue |
$96.1 billion |
$6.4 billion |
|
Revenue change (YOY) |
37% |
22.7% |
|
Operating income |
$6.2 billion |
$1.3 billion |
|
Operating income change (YOY) |
96% |
34% |
|
Free cash flow (TTM) |
$29.5 billion |
$536 million |
Sources: Amazon, Netflix. YOY = year over year. TTM = Trailing 12 months.
One of the key metrics to watch here is free cash flow. Netflix has been cash-flow negative for years and has used debt (now at $15.5 billion) to fuel its growth. That's not a big problem, but it's not sustainable long term. So, it was a good sign to see the company turn cash-flow positive for three consecutive quarters this year. While management expects that metric will return to negative territory in 2021, they also say they have a plan to get back to being free cash flow positive in the years ahead.
Amazon churns out massive quantities of free cash flow, which it habitually reinvests in growing the business. This year, Amazon has spent $25.3 billion on its property, plant, and equipment expenses, and invested heavily in delivery operations (think warehouses and transportation). Those investments help it please its customers and keep the pressure on its competition.
Advantage: Amazon
How they make money
While online sales produce the majority of Amazon's revenue, its cloud computing business, Amazon Web Services, produced 62% of the company's total operating profit through the first nine months of 2020. Additionally, its online advertising services are growing fast. Advertising is the primary source of sales in the company's "other" category, where revenue grew by 45% year-over-year to $13.5 billion in the year's first nine months. With diverse revenue streams, Amazon has several paths to fuel its growth.
Netflix makes its money from subscriptions, so it can grow revenues either by adding subscribers or raising subscription prices. It's done both in 2020. In the first three quarters, subscriber count rose by 28.1 million, eclipsing 2019's full-year total. And in late October, Netflix announced it was boosting the price of its standard subscription by $1 a month to $13.99, and its premium subscription by $2 a month to $17.99. Those moves will boost revenue, but they might lead to slower subscriber growth in this period of increased competition. Several new streaming services have launched since last fall, including Disney's Disney+, Apple's Apple TV+, AT&T's HBO Max, and Comcast's Peacock.
Advantage: Amazon
The better buy right now
Netflix and Amazon have been big winners this year, and they're priced that way. Amazon's forward P/E ratio is 55, while Netflix's is 56. These companies have always carried premium valuations, but they've also always rewarded investors who bought shares and held them long term.
Netflix has a competitive advantage in streaming video, with 195 million subscribers and an expansive content library that promotes customer loyalty. The most recent price increase was the third since October 2017, but the company has kept adding subscribers -- 28.6 million in 2018; 27.8 million in 2019; and, it estimates, 34 million this year. That's pricing power.
However, I think Amazon has two long-term advantages -- a more diversified revenue stream and substantial free cash flow, which Bezos and company have proved they will use to drive future growth.
Right now, I believe Amazon is the better buy.
