Netflix surprised investors with better than expected subscribers growth in the second quarter of 2017. Several days ago Netflix released its financial statements which must have made its shareholders very happy because the stock shot up 13% the next day. The online streaming company added over five million new subscribers around the world, which is more than the original expected number of 3.2 million. About 1.1 million of the new subscribers were from the United States of America, and 4.1 million came from other countries.
But despite the positive surprise, some analysts are warning that NFLX has become too expensive to own from an evaluation point of view. More subscribers should translate into higher profits later down the road, but at the moment its revenue is in line with Wall St.’s estimates. Plus it actually reported lower earnings than the consensus, although not by much – only one cent per share. Netflix currently has a price to earnings ratio of 225 times, even higher than Amazon.com’s expensive P/E ratio of 193 times. Furthermore, its price to sales multiple is at 8.3, which is much higher than its five year average. From a fundamental analysis point of view, Netflix does not look cheap. Many analysts believe it is now a good time for some NFLX shareholders to take some profits before it’s too late.
“I think chasing Netflix now is an expensive affair,” says Seeking Alpha contributor David Butler. “It seems to be following the same mania as Tesla and Amazon where investors will run up the price on speculation alone regardless of actual earnings. To a degree it makes sense, but things are getting out of hand.”
American TV personality Jim Cramer who studies the markets has included Netflix in a group of tech stocks he called FANG. The name is an acronym for Facebook, Amazon, Netflix, and Google (or Alphabet.) He once said that these 4 companies are solid, long term holds because they never stop innovating which gives them their competitive edge. He may be on to something. Year to date all 4 stocks of FANG have made double digit returns for investors. FB is up 32% since the beginning of the year. AMZN is up 29%. NFLX is up 41%. And finally, GOOG is up 25%. But after some time even Cramer himself has admitted that Netflix may not be a suitable contender in a growth portfolio anymore. Eventually Cramer renamed FANG to FAAA as the new set of stocks for long-term growth. The new abbreviation of FAAA represents Facebook, Alibaba, Alphabet and Amazon.
Similar to other hot stocks, I think that Netflix’s stock price no longer reflects its current level of growth and profitability. Yes it has over 100 million subscribers, about half of which are from the U.S. This makes it one of the largest global entertainment subscription companies. But it is very difficult to assume that Netflix will continue to grow its subscriber base as fast as it has in the past. I would give NFLX a hold rating at this point.
The entertainment company was founded by Reed Hastings and Marc Randolph nearly 20 years ago. Netflix’s initial business model included DVD sales and rental, although Hastings jettisoned DVD sales about a year after Netflix’s founding to focus on the DVD rental by mail business. In 2007, Netflix expanded its business with the introduction of streaming media, while retaining the DVD and Blu-ray rental service. The company expanded internationally, with streaming made available to Canada in 2010 and continued growing its streaming service from there; by January 2016, Netflix services operated in over 190 countries.
This author holds 10 shares of NFLX and does not plan to sell within the next 72 hours as of writing this post.