Two ways to look at NFLX’s amazing run.

In the fall of 2013, Netflix CEO Reed Hastings thought Netflix stock might be too damn high. He worried publicly that “momentum-investor-fueled euphoria” could be behind the rapid rise in Netflix shares, which were then trading around $48.

Investors ignored Hastings’ advice. Since then, the stock has risen 500 percent. It’s up more than 60 percent in 2018 alone, and is currently trading around $307.

So is that price too high?

Depends on how you look at it.

Here’s an argument that Netflix shares are more reasonably priced than they were in 2013: The company’s price-to-earnings ratio — simply, the price of its stock divided by its trailing 12-month profit — has actually declined since then. In the third quarter of 2013, Netflix’s stock was trading at 260 times its earnings, according to FactSet data. Today that ratio is 206. That is: Investors are paying $206 for every $1 of profit.

That’s still not “cheap” — the average company in the S&P 500 is trading at 20 times its earnings. High-flying growth stocks like Amazon and Facebook are trading at PE ratios of 237 and 30, according to FactSet.

But it does reflect the fact that Netflix’s bottom line has been growing. In the last quarter of 2013, the company posted a profit of $48 million. Last quarter, that number had shot up to $290 million.

However, when you look at Netflix’s enterprise multiple, you get a different picture. That’s a measure which compares the company’s enterprise value — market cap plus debt, minus cash — to its earnings before taxes, interest, depreciation and amortization. It’s useful for investors who are trying to figure out what a company would really cost in an acquisition, particularly when they’re looking at a company with a lot of debt.

And Netflix has a lot of debt: It currently has $6.5 billion in long-term debt and it just announced plans to take on an additional $1.9 billion. (Also on investors’ minds: Another $18 billion in long-term content obligations.)

All of which means that Netflix currently has an enterprise value of 17.6 times earnings — more than double what it was when Hastings said the stock was high. The S&P 500 average is about 13 times.

What this tells us is that Hastings’ 2013 rebuke of investor “euphoria” might apply today, even if he has stopped making public comments about his company’s stock price. Debt is a huge part of how Netflix’s business operates — for now — since it relies on paying big checks to content creators. That’s why despite booking quarterly profit, Netflix’s cash flow remains negative, meaning more money continues to go out the door than comes in.

Recode – All Go to Source
Author:

Rani Molla

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