Putting money behind broad themes that you see shaping up across the economy is a smart way to benefit from secular trends. The media and entertainment industry provides a great example.
While there are numerous streaming stocks that investors can choose from to gain exposure to the powerful trend of internet-based video entertainment, I don't think it's even necessary to put the effort in to try and identify a single winner. A dominant company is already easy to recognize.
I'm talking about Netflix (NFLX -0.63%). Here's why investors should choose this stock to play the rise of streaming entertainment.
First-mover advantage
At the end of the most recent quarter (the third quarter of 2023, which ended Sept. 30), Netflix had 247 million subscribers, 10.8% more than a year ago. This puts it ahead of every other streaming service on the market, a testament to Netflix's first-mover advantage in the industry. Co-founder Reed Hastings figured out nearly two decades ago that the internet was going to revolutionize the way people watched TV. And he was right.
Today, Netflix is a global entertainment powerhouse, with a presence in more than 190 different countries and trailing-12-month revenue of $32.7 billion.
That scale, both in terms of revenue and the number of members, is a huge benefit to Netflix versus subscale streaming providers and even larger ones too. Netflix can spend more on content on an absolute basis than rivals, to the tune of $17 billion this year, while also spreading out its fixed costs among its massive user base. As revenue hopefully rises at a faster clip than the cash outlays going to content production, Netflix's unit economics will improve, as they have historically.
Additionally, since it's been an industry leader for such a long time, I don't think any of Netflix's competitors have the treasure trove of data that it does. This can help guide what content to license or create, but it can also support the company's strategic priorities.
Robust financial picture
While most streaming services burn billions of dollars, Netflix is already consistently profitable. After posting an operating margin of 17.8% in 2022, management expects it to be 20% this year. It's not crazy to assume this metric can steadily rise in the years ahead. After all, Netflix registered an operating margin of just 10.2% in 2018, showcasing its ability to scale up profitably.
But cash is king, right? For a business that spends tens of billions of dollars on content each year, investors want to know about Netflix's free cash flow (FCF). Netflix is showing off in this regard, with FCF forecast to total $6.5 billion this year.
The recent introduction of the cheaper, ad-supported tier can provide even more financial upside. CFO Spence Neumann said on the second-quarter 2023 earnings call that option was generating more revenue per user than the standard ad-free plan in the U.S. I'd guess that ad revenue is extremely high-margin, so as more consumers choose the ad-based tier, Netflix's margins could get bumped up.
Reasonable valuation
Even after Netflix shares have jumped 45% in the past 12 months (as of Oct. 18), the valuation isn't too excessive. For a stock that has typically traded at a steep price-to-earnings (P/E) ratio for a long time, its current P/E multiple of 37.8 doesn't look too bad. And on a forward basis, it's even more reasonable, selling for a P/E of 29.8.
Given that Wall Street expects Netflix's FCF to rise at a compound annual rate of 43% between 2022 and 2027, investors might view shares as being downright attractive from a valuation perspective in the context of the company's long-term outlook. Of course, take these forecasts however you may. But it's hard not to get excited.
It's a fair assumption that the streaming industry is still in a state of flux, with the industry still evolving and the ultimate competitive landscape still hard to determine. However, I don't see Netflix's dominance in the space eroding anytime soon. It has long been the leader in streaming, and that is set to continue in the years ahead.
