Have shares of Netflix (NFLX +14.03%) finally peaked? That's the million-dollar question. Currently, shares of the streaming video service provider are trading at an all time high of over $345 a share.
(graph made by author with data derived from http://finance.yahoo.com/q/hp?s=NFLX+Historical+Prices)
Looking at the graph above, we see that the company experienced a meteoric rise in share price after plummeting just shy of the $300 closing market price in July of 2011 to $53.80 in September of 2012. After the company announced a change in their pricing structure, shareholders fled from the stock for fear that customers, who were paying $9.99 per month for streaming and DVD rental services would now be forced to pay $7.99 per month for each service individually.
However, with Netflix posting record revenue in 2012, shares of the company quickly rose past their previous high, effectively netting a large return for investors who were confident enough to either hold their shares through that tough period or to buy near the bottom. After seeing the fall and subsequent rise in its share price, it is perfectly reasonable for investors to ask if now is the time to take profits, stay away from the company if you aren't an owner, or buy shares.
Profitability
Although the meaning of undervalued or overvalued might be subjective in nature for any given company's stock, we can utilize objective measures to help guide us in the right direction. One very interesting metric for Netflix is its net profit margin, which is a measure of how much of every dollar in revenue it turns into profit. Over four of the past five years, the metric has been fairly consistent, fluctuating between 6.1% in 2008 to a high of 7.4% in 2010, and averaging 5.6% over the past five years. However, due to rising costs, the company's net profit margin declined to 0.5% in 2012, a trend that appears to have continued throughout the company's 2013 fiscal year to date.
Despite this substantial decline, the company's share price has rallied. But, the big question here is why. Why, with costs rising, should the market respond positively? Although the breakdown of the reasons in the company's financial statements aren't as detailed as I would like, it is still possible to derive a lot of information from them. The primary driver behind lower net income relates to the composition of the costs. As opposed to being brought about by impairment charges or a bloated workforce, the company's costs have risen due to increased expenditures relating to content acquisition and licensing fees, both of which suggest that the company is essentially foregoing profits now so that they may reap larger returns in the future.
When I analyzed the company's recent 10-K, I discovered that its international customers increased by 229.4% from 2011 through 2012, while its cost of revenue rose 342.5%. The same phenomenon appears to be taking place throughout 2013 as well. The rationale backing this is that the company is trying to gain a foothold in international markets, a strategy that may prove to be less profitable for the time being, but which could be an asset to the company as its market presence matures. Despite this though, the actual cost per subscriber on a cost of goods sold basis is decreasing when you compare 2011 and 2012, decreasing from $77.70 per subscriber to $73.99.
However, Netflix seems to be alone on this issue. For instance, Sirius XM Radio (SIRI +0.00%), another content provider, has seen its cost per subscriber rise a little over the same time period from $51.21 to $51.44. Pandora Media (P +0.00%) has seen a more significant increase from $3.65 to $4.43. Although the percentage increase is higher, it is interesting to note that it is, by far, the lowest among the three, whereas Netflix is the highest. This could indicate that Pandora Media is relatively cheap from a cost perspective, while Sirius XM Radio is middle-ground and Netflix is considered costly.
How Much Are You Really Paying for Netflix?
Accordingly, I concluded that Netflix is growing rapidly, and that its profitability is reasonable, despite what is likely a short-term to intermediate-term reduction in profitability as it seeks out growth opportunities in the international arena. However, in addition to paying for growth (something I never like to do personally), the overall cost of Netflix is rather high, as can be seen in the table below:
According to the above information, which lays out the cost that you, the investor, are paying for each subscriber, we can gain a relative understanding of how expensive shares of Netflix truly are. For instance, by the end of 2012, an investor buying shares in the company would have paid approximately $145.07 for each subscriber of Netflix's service. In return, each subscriber would have brought $101.67 worth of revenue into the company. Compared to historical results, this actually implied that the company was likely undervalued, especially when looking at the $463.50 that an investor paid for $108.13 in revenue in 2010, shortly before the stock's price declined precipitously.
Since 2012 though, the company's price has risen dramatically once again. Although it's still below its cost when pitted against its 2010 fiscal year, the $442.05 that an investor pays for a subscriber compared to the $101.67 in revenue that said subscriber will bring to the table for 2013 (assuming that for the company's 2013 revenue are accurate and assuming that steady subscriber growth continues) is very high. By dividing the $442.05 by the $101.67, you arrive at a ratio of 4.43, which is the number of dollars you are willing to pay for each dollar a subscriber will bring in. Although this is high compared to historical norms, it is far lower than the 7.38 ratio given by Sirius XM Radio and significantly lower than the 11.64 ratio given by Pandora Media.
It's possible that Netflix is overvalued but, when compared to Sirius XM Radio and Pandora Media, is relatively cheap, which could give the Foolish investor an idea of which companies are most appealing to them if any at all. Personally, while I find the growth prospects of each appealing, I would stay away from all three, especially Sirius XM Radio and Pandora Media.
