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Why Peter Lynch Would Love Netflix

By Rich Duprey – Aug 27, 2021 at 8:37AM

Key Points

  • Netflix was a superstar during the pandemic and continues to grow today.
  • Peter Lynch would like its straightforward, easy-to-understand business.
  • The streamer has significant room for further growth.

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The streaming service's stock isn't cheap, but the investing legend wouldn't mind paying up for quality.

Peter Lynch made the stock market more accessible to investors through his two classic books, One Up on Wall Street and Beating the Street. They described an investment philosophy for finding and buying winning stocks that anyone could understand.

Lynch's common-sense approach to investing suggested looking for companies that were easy to understand or which everyone knew, and then diving deep into their business to research their strengths.

For the 13 years he ran the Fidelity Magellan Fund, Lynch averaged a 29% annual return that consistently more than doubled the return of the S&P 500 market index. Here's why the investing great would surely love Netflix (NFLX 3.14%) today.

Two people sit on a couch. One of them holds a television remote.

Image source: Getty Images.

Bringing the big-screen experience home

Even if someone hasn't subscribed to Netflix's streaming service, almost everyone knows it exists and what it does. 

While its business may have grown slightly more complicated with the addition of backing and producing original content, its primary business of movie streaming is easy to understand: Consumers subscribe to its service for a fee and can watch an unlimited number of movies and TV shows on their television, computer, or mobile device, and do so commercial-free.

Viewers can even still rent DVDs by mail if they want to. It's a negligible part of its operations these days, accounting for less than 1% of revenue last year, but it's still available.

The streaming part of its business, though, is much more robust, generating more than $24.7 billion in revenue last year. It's running 22% higher over the first six months of 2021, and importantly, its subscriber count continues to grow as well. Even going up against the tough numbers from the pandemic, Netflix ended the second quarter with 209 million paid memberships, up 1.5 million and ahead of its forecast of 1 million new subscribers.

Obviously it's going to be a slower growth environment compared to when consumers were locked down in their homes, but the gains indicate people are keeping their subscriptions despite having more out-of-home entertainment activities to choose from.

Doing something original

A lot of that is because of Netflix's original content. Unlike when it was mostly an either-or choice between it and Amazon's Prime Video, viewers now have an abundance of streaming service options -- arguably too many. It's almost getting to the point when cable and satellite TV dominated people's viewing habits and there were 500 channels but nothing to watch.

There's a lot of overlap in the content available on the competing services, so it's how they differentiate themselves with original and exclusive programming that determines who can draw in the most viewers.

Netflix got into original content with the debut of House of Cards back in 2013, the first show produced by a studio for the streamer. It was a risk for Netflix back then, but it paid off big because unlike Walt Disney, HBO, Paramount, and other media companies, it didn't have a catalog of movies and shows of its own to fill up its inventory.

At the same time, Netflix was smart enough to also realize it would need to prepare for the day studios begin yanking their content from its platform for exclusive use on their own streaming services, and it began investing heavily in original programming. 

Today, while there's a lot of chaff among the wheat of Netflix Originals, the service has produced a number of intriguing, quality shows that serve as a draw to the platform. Netflix now also produces a lot of content for all of the local markets it serves. 

It's expensive -- the quarterly cost of revenue now exceeds $4 billion -- and operating margin declined to 25% from 27% a year ago, but it's well above the 14% margin Netflix produced in 2019. Moreover, while revenue has surged 49% over that two-year period, content costs have only risen 30%, showing that the improved content library still generates more money than it's paying out.

Woman with laptop in front of numerous screens

Image source: Getty Images.

Paying up for quality

Netflix is a household name, the kind of ubiquity that Lynch used to look for in a stock. Delving into the streaming platform's business reveals that even with a tsunami of competition flooding the market, its operations are not only solid but growing.

Netflix stock is not cheap, going for 43 times next year's earnings estimates, but then the streamer rarely ever offered a discount as investors always knew they were paying up for quality. 

That means with Netflix stock only up 2% year to date, but down 7% from the high it hit in January, this just might be the time when Peter Lynch would make his move on Netflix shares. Wall Street is worried about how well Netflix can perform against last year's comparables, but the streaming service is showing it can still grow, even in difficult times.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon, Netflix, and Walt Disney. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon and short January 2022 $1,940 calls on Amazon. The Motley Fool has a disclosure policy.

Stocks Mentioned

Netflix Stock Quote
Netflix
NFLX
$320.01 (3.14%) $9.75
Walt Disney Stock Quote
Walt Disney
DIS
$93.38 (0.90%) $0.83
Amazon.com Stock Quote
Amazon.com
AMZN
$89.09 (-1.40%) $-1.26
Fidelity Magellan Fund Stock Quote
Fidelity Magellan Fund
FMAGX
$11.27 (1.17%) $0.13

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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