The tech sector has fallen a long ways since the heady days of the dot-com bubble. But if you're looking for stocks trading at lofty multiples, technology and e-commerce might still be your best bet.
One of those seemingly pricey stocks right now is movies-by-mail pioneer Netflix
Pedal to the metal
See, Netflix can control its earnings to a very large extent. CEO Reed Hastings and his gang have a gas pedal at their feet, and can adjust earnings to their hearts' content: If business is bad and the new subscriber count isn't rising quickly enough, management pulls back on advertising expenses. When consumers are responding to marketing, sales will increase, and so will the marketing push.
The current stated goal is to stay at a 10% operating margin, and that's easily done by adjusting the advertising budget. Since the company is managing its expenses with tight reins on that important expense, you can assume that earnings will stay pretty stable -- come hell or high water. And that's why the P/E ratio means next to nothing for this company.
OK, then what do you look at?
It's more instructive to look at cash flows here. That figure will give you a truer sense of how Netflix is doing than the deftly manipulated and static earnings ever will.
And from that perspective, Netflix suddenly doesn't look too pricey anymore. Netflix has grown its free cash flows by 57% a year over the last three years, and the price-to-FCF ratio has stabilized in the lower 20s -- currently at 23.2 times trailing free cash flow according to Capital IQ.
That puts Netflix right next to grown-up value play Microsoft
You might want to accuse me of cherry-picking a metric to make Netflix look cheap. If that's what I wanted to do, I could put this stock's 13.2 EV/EBITDA ratio next to Amazon.com
But by the same token, Netflix is not terribly expensive, either. Is today's price point the ideal buy-in point for would-be Netflix investors? Maybe not. But as a current and longtime Netflix owner, I feel confident that Netflix is not overpriced, and I am not about to sell out and take profits today. Netflix isn't a screaming sell, either, not by a long shot.
Looking ahead a few years (like any true long-term investor should) I see Netflix becoming an early leader in the coming digital media revolution, competing with the likes of Apple, Amazon, and TiVo
So Netflix isn't cheap but it's also not expensive, especially when you consider what you're paying for. Do you see years of growth ahead like I do, or am I getting the wrong idea altogether? Let me know in the comments below.
Fool contributor Anders Bylund owns shares in Netflix and Google, but he holds no other position in any of the companies discussed here. Google is a Motley Fool Rule Breakers recommendation. Apple, Amazon.com, and Netflix are Motley Fool Stock Advisor selections, and Microsoft is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days. You can check out Anders' holdings and a concise bio if you like. The Motley Fool is investors writing for investors.
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