Netflix: The Ultimate Growth Stock

by: Friedrich Research

Growth Investing is very difficult to practice as one piece of bad news can send your stock crashing down in price. This happens mainly because expectations are always so high and perfection is expected. Thus as a growth investor you are forced to have just a limited number of holdings in your portfolio. This is done as one needs to be a hawk at all times and watch what is happening in one’s portfolio for a potential negative events. It’s a matter of time and not a lack of opportunity that forces one to have such a non-diversified portfolio. There are many wonderful growth stocks out there, but there is just not enough time to watch over more than let’s say 20 holdings at a time.

A perfect example of a negative event was when Blockbuster's (BBI) management issued a warning to its investors Tuesday night of a potential bankruptcy happening a lot sooner than the investing community has expected. Here is the link for the Blockbuster news that caused the stock to crash 25% in after hours trading.

Netflix's promise

The easiest way to show everyone why I think Netflix (NASDAQ:NFLX) is the ultimate growth stock is to first introduce everyone to the type of growth investing that I practice. My work is based on the theories and methods of the father of “Qualitative Analysis”, Philip Fisher. To read more about him please go here.

Netflix, in my opinion, is one of the best managed companies in the world and has one of the greatest and most unique business models around. It’s a business model that cannot be easily duplicated, because it is based on the unique relationships that it has built up with movie studios, the postal service and the like, that helps create a wide moat or large barrier to competition.

For example, while Blockbuster and Movie Gallery (MVGR.PK) have to pay for rental space and hire employees to run their stores, Netflix only operates shipping warehouses to send and receive its DVDs. It sort of runs like (NASDAQ:AMZN) but trades at a price to free cash flow that is much lower than Amazon's by a wide margin.

Amazon and Netflix both have very unique business models, but NetFlix is not as well known as Amazon and is still a mid-Cap stock while Amazon is a large-cap. While both have amazing FROIC’s, (free cash flow to invested capital) NetFlix beats out Amazon on the price to free cash flow front and is in my opinion still undervalued relative to its amazing growth rate. I have written an instablog analyzing NetFlix’s FROIC and Price to Free Cash flow and if anyone is interested they can view it here.

One of Fisher's main points is to find companies with management that has been at the helm for a number of years and who are very consistent in what they do. Both the CEO and CFO have been with the company since its founding in 1998. From zero subscribers the pair built Netflix up to its current subscriber base of over 13 million.

If you go back and read the annual reports and listen to the various conference calls [the most recent, Q409 is here,] you will find a management that is not only brilliant and innovative, but which is also not in a rush and whose members think in the long term. They can be compared to Steve Jobs of Apple (NASDAQ:AAPL) in their approach. Calmness and confidence when matched with consistency and an extremely unique business model makes for a winning combination.

Netflix has also allowed its name to be included on the majority of new DVD and game consoles that are going to be produced from now on, without charging these manufacturers any kind of fee. Thus by being in a majority of the products, the company can offer its new streaming digital service to its customers with no hardware costs.

I personally use Netflix's service and am on its 5 DVD at a time plan, but one can sign up for as little as 1 DVD to as many as 8 DVD’s sent at a time. The brilliant move is that if you just subscribe to the $8.95 one DVD at a time plan you also get access to 17,000 movies delivered to your home via an internet connected device. I personally just have my laptop connected to my big screen TV via an HDMI cable and I don’t even need to go spend any money on a new device.

For about $40 a month, I get my DVD’s delivered to my house and then get streaming digital movies sent to me via my internet connection. I love the service so much that I actually canceled my cable TV service and save myself about $90 a month.

I asked my postman how many NetFlix mailings he delivers on an average day. I was expecting 5 or 6, but he shot back 'about 40!' You can now see why NetFlix delivers close to 2 million DVD’s a day. That’s a lot of happy customers who don’t have to get in their cars, drive to the video store and then drive back. I basically watch one DVD a night, put it in my mailbox and then when the mailman comes, he picks up the old one and drops off the new one. So by subscribing to 5 at a time I am never left without a movie to watch. In the rare times that I am, I have 17,000 movies available to me anytime to choose from.

Finally I am looking forward to seeing how well Netflix movies are going to run on my Apple (AAPL) IPad when that product arrives in April. I can go on for hours explaining why Netflix is in my opinion the ultimate growth stock, but will stop here as I have already written four pages and don’t want to force the Seeking Alpha editors to have to work overtime.

The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about. Please note investments involve risk and unless otherwise stated, are not guaranteed. Past performance cannot be used as an indicator to determine future results. Strategies mentioned may not be suitable for everyone. We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter “Mycroft” Psaras, and should not be construed as personalized investment advice. Information expressed does not take into account your specific situation or objectives, and is not intended as recommendations appropriate for you. Before acting on any information mentioned, it is recommended to seek advice from a qualified tax or investment adviser to determine whether it is suitable for your specific situation.

Disclosure: Long NFLX, AAPL, with no position in BBI, AMZN or MVGR.PK