Netflix (NFLX 1.35%) shares have soared nearly 70% over the past 12 months, extending its 2,300% rally over the past decade. The streaming media giant has lots of strengths, including a market-leading position, solid sales and subscriber growth, and critically acclaimed original content. But Netflix's business can still be disrupted by telcos launching first-party streaming services, content providers raising their fees, and other tech ecosystem leaders evolving into streaming rivals.
Netflix's profit margins also remain paper-thin, and the stock trades with an astronomical trailing P/E ratio of 351, a forward P/E ratio of 91, and a 5-year PEG ratio of 6.3. Those figures all suggest the stock is supported by optimistic expectations instead of fundamental growth. While Netflix might still be a great long-term play, investors looking for a better balance between stability and growth might consider two other stocks: Amazon (AMZN 7.38%) and Google parent Alphabet (GOOG 7.27%) (GOOGL 7.28%).
Why Amazon is a better buy than Netflix
At first glance, Amazon suffers from the same valuation problems as Netflix. Its stock currently trades at 466 times trailing earnings and 68 times forward earnings, and it has a 5-year PEG ratio of 3.1. But since both Amazon and Netflix prioritize generating top-line growth and enough free cash flow to expand their businesses, their EV/FCF ratios offer investors a more accurate picture of how "cheap" each stock actually is. Amazon's EV/FCF ratio of 36 is much lower than Netflix's ratio of 50, and it currently hovers near a multiyear low.
Amazon still isn't a cheap stock, but it has a much wider moat than Netflix. Research company CIRP recently estimated that members of Amazon's Prime ecosystem spend about $1,100 annually on the site, while non-members only spend $600. The company also estimated that its total number of U.S. members rose 35% over the past year to 54 million. As long as Amazon keeps expanding that ecosystem with new smart-home devices, digital products, and home delivery services, that user base should keep growing.
Amazon also owns the largest cloud infrastructure platform in the world, AWS (Amazon Web Services). AWS started out as Amazon's own cloud backbone, but it now provides cloud services for data-hungry clients like Netflix, the CDC, and even NASA. That growing business is also becoming Amazon's most profitable business unit. Last quarter, the unit's operating income surged 161% to $687 million, or 39% of Amazon's operating profits. Morgan Stanley analyst Brian Novak forecasts that AWS will generate about 60% of Amazon's incremental profits by 2017. That growth should offset the thin margins of its marketplace business and make Amazon a more consistently profitable company than Netflix.
Why Alphabet is a better buy than Netflix
Alphabet's Google and Amazon are both chasing Netflix in streaming video, but neither company has caught up yet. But like Amazon, Google has a wider defensive moat than Netflix. Google owns the world's largest search engine, the largest mobile operating system, and the top mobile web browser in the world. Those three pillars of growth feed data into its core advertising business, which posted 17% annual sales growth last quarter.
Investors also won't have to fret over Alphabet's earnings and valuations. Last quarter, the company had a healthy non-GAAP operating margin of 32%, while its non-GAAP net income soared 30% annually. Alphabet stock currently trades at 31 times trailing earnings and 18 times forward earnings, and it has a 5-year PEG ratio of 1.3. Its EV/FCF ratio of 27 is also much lower than Netflix's and Amazon's ratios.
Google notably lacks Amazon's e-commerce and cloud strength, as well as Facebook's social networking muscle. Those weaknesses represent ecosystem barriers Google struggles to cross, but the company continues to invest in all three areas to challenge both rivals. Furthermore, Alphabet continues to invest in new technologies like driverless cars, smart-home devices, fiber connections, and even medicine. While those "other bets" only generated $448 million in revenues while incurring $3.57 billion in losses last year, those investments could eventually reshape Alphabet's business over the next few decades.
But don't dismiss Netflix yet...
Amazon and Alphabet might seem like "safer" stocks today, but investors shouldn't underestimate Netflix's ability to evolve. After all, Amazon started out as an online bookstore, while Google was initially just another search engine in a sea of similar players.
Netflix already evolved twice, first from a mail-based rental service into a streaming one, and then from a content licensee into a content creator. It's certainly possible for Netflix's next evolution to diversify its business, widen its moat, and boost its profitability in ways investors haven't even considered yet.