- Human greed and self-delusion are the drivers of bubbles in a market.
- Netflix is trading at 184 times trailing earnings and 94 times expected earnings on the back of the greater fool tendency of humans.
- Investors who purchase shares of Netflix today risk losing capital which could buy plenty of utility. Comparisons with 1637 tulip bulb utility provide insight.
Today we look at the tulip mania that reached its peak in 1637 with befuddled amusement. Why would anyone in their right mind pay thousands for a tulip bulb? They had and continue to have limited use, other than aesthetics, and produce little if any in terms of cash flow. The only explanation is that human greed and self-delusion built the tulip mania bubble. As long as there is an even greater fool out there willing to pay even more, buying something at any price is the most logical thing in the world.
Currently, the market continues to run higher and a few stocks are trading for ridiculously high prices in comparison to their earnings, yet Mr. Market continues to delude itself that again this time is different. As we have seen many times before that when the market is optimistic about the prospects of a company and is trendy to invest in, the valuation of said security will rise to ungodly proportions. It isn't until the market realizes that the parties over that the security's price falls precipitously.
Netflix (NASDAQ:NFLX) is one of those companies that is trading for ridiculously high prices in comparison to their earnings. Specifically they trade at 184 times trailing earnings and 94 times 2014 estimated future earnings. Prospects are that they can continue to grow in the US and abroad while taking customers away from cable and satellite providers. They have been able to acquire and create original content that has been received very well. Cord cutting could further shake up the industry, but there still are bottlenecks in the transmission of data to many of the homes in the US that currently prohibits full cord cutting. Additionally, content costs continue their rise and will continue to be a huge cost for Netflix and all other cable and satellite providers. Netflix customers could also be paying higher prices for larger bandwidth usage.
As a Netflix customer, I think the product they serve is good and it's cheap. As an investor, I think the price to buy Netflix is a very bad choice at current valuations and looks similar to previous bubbles. It is very hard to justify Netflix's 686% increase in share price in less than two years. The business has not changed that much in such a short period of time. As Seth Klarman stated in his 4th quarter letter "we're pretty sure we've seen this movie before." We agree. Valuations in the tech bubble of the late 90s looked very similar with valuations at 100x earnings and greater. It is hard to say when the movie will end, but it will end.
For an entertaining comparison, we have taken what could be bought for the cost of a single tulip bulb in Amsterdam, 1637 with what could be bought today for the cost of a single share of Netflix in the United States. The comparison is distorted because of today's mass production, different buying power and a share of Netflix could be split today which would make the price of one share less. The comparison could be insightful because the company has made such large gains in such a short period of time while the business has changed very little. The comparison is entertaining, nonetheless.
(Sources found below)
Netflix has not reached the epic nosebleed valuations that tulip bulbs once had, but the above chart gives investors perspective to how much utility $450 has today. At such a step valuation one can buy cash generating or useful livestock, plenty of food, entertainment or plenty of alcohol that would spice life up. Or if you subscribe to the greater fool theory, you might gamble all of that money and forgo plenty of utility. Future generations will more than likely look back to Netflix's valuation (and many other of today's hot stocks) with befuddled amusement similar to tulip mania.
Amsterdam, 1637 information is derived from Tulipomania written by Mike Dash.
Netflix comparison was made at a rounded up $450 a share. Information was derived from the following sources: