2020 was a big year for tech stocks, with the Nasdaq Composite rising 44%. Unsurprisingly, the popular FANG tech stocks, or Facebook, Apple, Netflix (NFLX 3.95%), and Alphabet (parent company of Google), all appreciated nicely as well. These stocks rose 33%, 81%, 67%, and 31%, respectively.
While these huge gains were exciting for shareholders, returns like this can lead to a bad case of FOMO (fear of missing out) for investors on the sidelines. Fortunately for investors still interested in tech stocks today, some good deals out there remain, including among the highly regarded FANG stocks.
Here's why investors may want to consider buying shares of streaming-TV titan Netflix today, even after the growth stock's 67% gain last year and another 2% rise year to date.
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Here comes Netflix's cash flow
If there were any doubts about Netflix's potential to generate billions of dollars of annual free cash flow someday in the future, the streaming-TV giant likely put those concerns to rest earlier this month. When Netflix reported its fourth-quarter and full-year 2020 results, management shared a strong vision for the economics of the company's business. This was promising news. The company had years of negative free cash flow as it aggressively built out its content library, hoping to drive significant subscriber growth and solidify the company's lead in a nascent, fast-growing market.
"Combined with our $8.2 billion cash balance and our $750 [million] undrawn credit facility, we believe we no longer have a need to raise external financing for our day-to-day operations," said Netflix management in the company's fourth-quarter shareholder letter. The company says that following what will likely be a break-even year for free cash flow in 2021, Netflix will become sustainably free-cash-flow positive.
Indeed, management is so confident in its improving financial profile that it's already considering the possibility of repurchasing shares -- a method of indirectly returning capital to shareholders by reducing total share count and increasing remaining shares' claim to ownership.
Netflix stock: cheaper than it looks
With Netflix's financial profile rapidly improving, the company's stock looks more expensive than it actually is. This is because analysts expect Netflix's economies of scale to start paying off significantly in the coming years, leading to outsize earnings growth. The current price-to-earnings ratio, therefore, arguably overstates the stock's premium.
Sure, Netflix has a price-to-earnings ratio of about 90 -- well in excess of Facebook's P/E ratio of 27. But consider this: Netflix's current stock price is equal to only 42 times analysts' average forecast for the company's 2022 earnings. This valuation multiple could come down rapidly in the coming years if analysts' view for Netflix's earnings per share proves correct. The current analyst consensus calls for Netflix's earnings per share to compound at an average annualized rate of 44% over the next five years.
As the company's years of aggressive investments in content finally start paying off in lucrative economies of scale, Netflix's bottom line could soar over the next five years. This could potentially make the company's stock price today -- as expensive as it might seem now -- look like a great entry point in the rearview mirror.
Of course, nothing is guaranteed in stocks. There are numerous risks. Competition could creep up and prove more challenging than expected. Further, the company may need to spend more money on content than it expects to keep customers. But Netflix stock's reasonable valuation today seems to leave room for some detours, making the investment worth risking some capital on.
