Is Google Setting Up to Knock Out Netflix?

With shares of Netflix (NASDAQ:NFLX) trading at around $216.74, is NFLX an OUTPERFORM, WAIT AND SEE or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s Movement

The shorts recently lost more than their shorts when Netflix beat expectations. However, just as the Netflix movie has played out so far, there has been a recent twist. Google Inc.’s (NASDAQ:GOOG) YouTube has just announced that it’s launching a paid subscription service starting at just $0.99 per month. While that $0.99 number is being thrown around a lot, the average price will actually be $2.99 per month. That might be a big difference, but it’s still considerably cheaper than the $7.99 per month for Netflix. On the other hand, Netflix crushes YouTube when it comes to content.

YouTube will begin with 30 partners and 500 channels, but it will roll out further in the coming weeks. As of right now, the two biggest launch partners are Sesame Street and Ultimate Fighting Championship. So, you can watch everything from Elmo singing “The Bear Went Over the Mountain” to caged warriors attempting to inflict as much future brain damage as possible. For those parties who are potentially interested in YouTube’s service without wanting to make a commitment, there is a 14-day free trial.

As far as Netflix goes, margins have been the issue. Based on industry trends, Netflix should manage to hold its own with margins. When there is money to be made for all parties involved, solutions are always found.

There has been a lot of debate about Netflix’s investment on House of Cards, which was $100 million. Though the number is smaller, it’s somewhat reminiscent of what Sirius XM Radio Inc. (NASDAQ:SIRI) did with Howard Stern. The goal was to make a big splash. Just by offering an exorbitant amount of money, it leads to a great deal of media attention. And if the investment is a good one, then it has the potential to pay off in a big way. Will House of Cards pay off for Netflix? Nobody can give a definitive answer to that question at this point in time, but it has an 8.9 rating on IMDB, which is phenomenally high.

In regards to traffic for Netflix, it has been up and down over the past year. According to Alexa.com, Netflix.com currently ranks #100 globally and #22 in the United States. Over the past three months, pageviews-per-user has declined 5.50 percent, time-on-site has declined 5 percent, and the bounce rate has increased 1 percent. These obviously aren’t good numbers, but they might relate to the improving weather. An interesting note for viewers (not necessarily investors) is that Netflix uses a highly advanced algorithm to determine what you might like to watch. In other words, you’re not seeing the same options as everyone else. This algorithm is based on many factors, including time of day and geographic location.

Bulls are focused on subscriber base growth and the likely expansion of subscription rates. In addition to that, the stock has shown resiliency in weak markets.

On the bearish side of the argument, Netflix has to hold off a lot of fierce competition, the stock is very expensive at 530 times earnings, margins still remain small, expenses are catching up to revenue, and the primary driver of cash flow is DVDs, which might be a dying business.

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Now let’s take a look at some comparative numbers. The chart below compares fundamentals for Netflix, Google, and Amazon.com Inc. (NASDAQ:AMZN).

NFLX GOOG AMZN
Trailing P/E 531.52 26.25 N/A
Forward P/E 69.28 16.50 80.37
Profit Margin 0.65% 20.92% -0.14%
ROE 3.31% 16.36% -1.11%
Operating Cash Flow -8.51M 16.56B 4.25B
Dividend Yield N/A N/A N/A
Short Position N/A 1.40% 1.80%

Let’s take a look at some more important numbers prior to forming an opinion on this stock.

T = Technicals Are Strong

Netflix has been one of the biggest winners throughout the broader market year-to-date.

1 Month Year-To-Date 1 Year 3 Year
NFLX 27.83% 133.8% 191.2% 137.7%
GOOG 12.75% 23.95% 43.94% 77.80%
AMZN 0.22% 4.32% 17.37% 109.4%

At $216.74, Netflix is trading well above its averages.

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50-Day SMA 189.12
200-Day SMA 139.70

E = Equity to Debt Ratio Is Normal

The debt-to-equity ratio for Netflix is weaker than the industry average of 0.30, but it still qualifies as normal (for now).

Debt-To-Equity Cash Long-Term Debt
NFLX 0.86 1.03B 700.00M
GOOG 0.10 50.10B 7.38B
AMZN 0.36 7.90B 3.04B

E = Earnings Have Been Decent

Earnings had been improving on an annual basis until 2012. For revenue, some might say that the rate of growth has slowed, which is true, but the rate of growth is expected to fluctuate. Whether or not revenue continues to increase or not is more important.

Fiscal Year 2008 2009 2010 2011 2012
Revenue ($) in billions 1.37 1.67 2.16 3.21 3.61
Diluted EPS ($) 1.32 1.98 2.96 4.16 0.29

When we look at the last quarter on a year-over-year basis, we see improvements in revenue and earnings.

Quarter Mar. 31, 2012 Jun. 30, 2012 Sep. 30, 2012 Dec. 31, 2012 Mar. 31, 2013
Revenue ($) in billions 0.870 0.889 0.905 0.945 1.02
Diluted EPS ($) -0.08 0.11 0.13 0.1336 0.05

Now let’s take a look at the next page for the Trends and Conclusion. Is this stock an OUTPERFORM, a WAIT AND SEE, or a STAY AWAY?

T = Trends Support the Industry

The average U.S. household watches approximately eight hours of television per day. Trends support the industry because people don’t want to pay about $100 per month for channels they don’t watch. With streaming video, you can watch what you want when and where you want to watch it. Streaming video is gaining momentum every day, and Netflix is a major player.

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Conclusion

Many arguments can be made that Netflix will succumb to the competition in the future. However, as is the case in many other industries, there will be room for more than one or two players. Consumers will choose which service they want based on their preferences.

Many stocks trading at or near their 52-new week highs tend to make new 52-new week highs. Therefore, there is good upside potential. And there is little doubt that Netflix will be a long-term winner. However, the stock is very expensive at the moment trading at 530 times earnings and 69 times forward earnings. One significant piece of bad news could have a devastating impact. Therefore, Netflix is currently a WAIT AND SEE.

Using a solid investing framework such as this can help improve your stock-picking skills. Don’t waste another minute — click here and get our CHEAT SHEET stock picks now.

All content posted should not be considered professional advice. Please do your own research and consult with a professional financial advisor before making any investment decisions.

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