Shares of the leading streaming services have underperformed during the broader market this year. Year to date, the widely followed S&P 500 index has tumbled 19%, but Walt Disney (DIS -0.53%) and Netflix (NFLX -0.77%) are down 39% and 71%, respectively.
One of the common themes surrounding the negative sentiment for both stocks is concerns around demand for streaming, especially after Netflix reported a subscriber loss of 200,000 in the first quarter.
To boost subscriber growth, Disney and Netflix have announced plans to offer ad-supported plans to widen the addressable market for their streaming platforms. Disney officially unveiled its plans in a press release on March 4, while Netflix indirectly gave investors a hint it was leaning in that direction on its Q1 earnings call.
The prospect of padding profits with lucrative advertising revenue is a catalyst worth watching, but one of these entertainment stocks is better positioned to benefit and deliver returns to investors from this opportunity.
How much ad revenue will each company produce?
While Netflix is the larger service, with 221 million subscribers compared to 138 million at Disney+, Disney has an advantage with its family-centered content. Advertisers would highly value getting in front of Disney's unique audience. Netflix's wide variety of adult content makes it potentially challenging for advertisers to know exactly who is viewing their ads.
Disney has another advantage in that it has expertise in ad-supported streaming through Hulu. Disney already has advertising technology in place and has a tremendous portfolio of brands to sell to advertisers, spanning Star Wars, Marvel, Pixar, and National Geographic.
However, Netflix might have more to gain due to its smaller amount of annual revenue compared to the advertising opportunity on its service. Analyst Michael Nathanson estimates that Disney will generate $1.8 billion in U.S. ad revenue by 2025, while Netflix is estimated to produce $1.2 billion.
Advertising revenue would move the needle much further for Netflix's $30 billion in total annual revenue, which is less than half Disney's current revenue of $76 billion.
Data by YCharts
Advertising revenue would comprise just 2.4% of Disney's business compared to 4% for Netflix. That would give Netflix a greater boost in growth and therefore more upside for investors.
What the numbers say
Netflix stock trades at a modest price-to-earnings (P/E) ratio of 16. Even though Disney is trading at the same price it did three years ago, its P/E is higher at 65 due to investments in streaming content. Content spending has pressured Disney's earnings per share and therefore caused the E in the P/E to plummet.
Data by YCharts
There are a few things to keep in mind regarding the market's perspective on Disney. Disney's diverse business, including theme parks, media networks, studios, and consumer products, requires large capital expenditures to maintain.
Companies with various reporting segments are usually discounted by the market due to the difficulty in evaluating all the moving parts across the business. Because of this, investors may never place the same value on Disney's streaming business as they do on a pure-play streaming stock like Netflix.
Comparing both companies' finances, Netflix is in a stronger position, which could earn the stock a higher P/E ratio over the long term than Disney.
- Disney has a net debt position of $39 billion -- more than half of Disney's trailing-12-month revenue.
- Netflix ended the first quarter with a net debt position of $8.5 billion -- less than a third of Netflix's trailing-12-month revenue.
- Disney's operating profit margin has dropped from over 20% a few years ago to under 10% primarily due to investments in streaming content and capital spending on theme parks.
- Netflix has the same growth opportunities in streaming, but it's not saddled with as much debt and generates a much higher operating margin of 20%.
Netflix is the better streaming stock
Netflix has greater upside from offering an ad-supported option to subscribers. The stock trades at a modest valuation, while it has a lighter debt burden and generates a higher operating margin.
There are many streaming services for investors to consider, but Netflix is still the leader. With over 200 million subscribers, it has the profitability to invest for long-term growth.
