Psst. Hey, buddy! Want a stock tip? This company should blow the top off your portfolio.
Hmm. I think I'll stop right there before an image of me as a seedy character in a trench coat selling watches of questionable provenance gets too ingrained in your mind. But I really do believe that one particular company is undervalued, even though it looks expensive to Wall Street.
Rather than making you wait 'til the end of this article to find out what that one company is, however, I'm going to give it to you right up front. And then I'm going to tell you why I think it's undervalued, using three of the six criteria of a rule breaker from our Motley Fool Rule Breakers newsletter service.
Ready? Here it is
The company I'm thinking of is Netflix
Wall Street says it's too expensive. The P/E is 35, well above the market's average. The price-to-book is 19, which is outrageous. And of the 34 analysts covering the stock, 19 of them say to either hold it or sell it. Let's look at a couple of them.
Back on Nov.24, Wedbush downgraded Netflix to "underperform" (read "sell"), writing, "We believe that the stock's current price reflects investor expectations for growth well above what can be reasonably expected." Two months later, they upgraded the stock to "neutral," immediately following Netflix's last earnings report, after growth showed itself to be stronger than Wedbush had assumed.
Lazard Capital Markets also doesn't know what to do. Two weeks before Netflix's last earnings report, they had downgraded it to "sell," only to reverse themselves after the report, upgrading to "hold" the morning after.
Bank of America, on the other hand, has upgraded Netflix to "buy" (after the earnings report), but that's a distinctly minority position.
How to confound Wall Street
Everybody expects Netflix to get beaten, but it keeps delivering strong results, quarter after quarter. How does it do this? Well, it exhibits many of the properties that David Gardner, co-founder of The Motley Fool, has outlined as necessary for companies to grow for years.
First, it has strong consumer appeal. David writes:
A brand also becomes associated with an experience. We're creatures of habit, and when we have to think less, it makes our lives seem easier. The habit that comes from a strong brand ... immeasurably strengthens a company against its competitors.
Netflix's brand is all about delivering movies to you cheaply and conveniently. When Wal-Mart
Today, the worry is about streaming movies from companies like Google's
Second, it's had strong past price appreciation, especially since 2005. David agrees this seems counter-intuitive to finding future strong price appreciation, but companies that have a good chance of continuing to grow in the future have shown that they can grow in the past. For years, companies like Microsoft
Third, it's grossly overvalued according to the financial media. David writes, "The 'too expensive' label comes from underestimating how a Rule Breaker can disrupt its industry, displace competitors, and grow over a relatively short time." That's Netflix. I've already given you a couple of its metrics. Heck, its P/E ratio has averaged in the 20s and 30s for years. And go back to the Wedbush quote, above: the price was too rich for "what can be reasonably expected." Yet Netflix has showed that to be wrong, so far. Plus, it's just about eliminated Blockbuster as a rival, which had been operating using an old business model that goes back to the first days of VHS rentals. Talk about a new model disrupting an industry!
There you have it; Netflix meets three of the six criteria David's laid out for a company to grow for years. With a bit of thought, I'm sure you can come up with other examples that fit the bill.
For instance, Whole Foods Markets
I believe that a pretty good case can be made that Netflix also fits the other three of David's criteria. If so and if Netflix can continue to confound both its competition and Wall Street, then there's a good chance that it is still way undervalued compared to where it will be just a few years from now.
To find out what those other three criteria are, and to get the latest ideas on other companies that fit them and can potentially "blow the top off your portfolio," sign up for a free 30-day trial to Rule Breakers today and see for yourself.
Fool Jim Mueller owns shares of Apple, Netflix, and has a beneficial ownership in Microsoft. Home Depot, Microsoft, and Wal-Mart are Inside Value picks. Google is a Rule Breakers selection. Apple, Netflix, and Whole Foods are Stock Advisor recommendations. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool's disclosure policy broke the rules when it was young, and has continued growing ever since.