But how, you will ask, does one decide what [stocks are] "attractive"? Most analysts feel they must choose between two approaches customarily thought to be in opposition: "Value" and "growth" ... We view that as fuzzy thinking ... Growth is always a component of value [and] the very term "value investing" is redundant. -- Warren Buffett, Berkshire Hathaway (BRK.B) annual report, 1993
We take Buffett's thoughts one step further. We think the best opportunities arise from a complete understanding of all investing disciplines in order to identify the most attractive stocks at any given time. We therefore analyze each stock across a wide spectrum of philosophies, from deep value through momentum investing. This involves performing significant valuation analysis, both on a DCF and relative value basis, as well as a strong consideration of the firm's fundamentals (cash flow, risk, etc.), technicals and momentum indicators. The best stocks, we believe, will be attractive from a number of investment perspectives -- from value through momentum (hence our name, Valuentum). On the other hand, the worst stocks will be shunned by most investment disciplines and display expensive valuations and poor technicals and momentum indicators, in our opinion.
As part of our process, we employ a discounted cash-flow model to arrive at a fair value estimate for every company within our equity coverage universe. In Neflix's (NFLX) case, using a discounted cash-flow model is the best tool for valuation as we think it enables investors to steer clear of emotional investing, thereby avoiding behavioral tendencies, which often end badly. We outline below our valuation summary for Netflix and offer a friendly challenge to readers to arrive at a fair value estimate via a DCF process (based on reasonable assumptions) that comes anywhere near Netfix's current stock price. Our DCF model valuation template can be found here (the template can be re-used to value any other operating firm you wish). We will post your results on Netflix and the defense of your assumptions, should they be reasonable, on our website for further debate on the valuation of this firm.
Under perhaps the best scenario imaginable -- one that sees revenue expansion over 30% for each of the next five years, on average, and earnings growth that reaches nearly $15 per share by the end of the fifth year in our projection period -- we can only reach a valuation of about $190 per share for Netflix ... and this is an optimistic stretch. Under this exceedingly optimistic scenario, we discount future free cash flows with a weighted average cost of capital assumption of 10%, which may be a touch light given the tremendous risks (upside and downside) related to the company. In other words, Netflix's valuation is a significant market outlier, and we can find little substantiation for its current stock price. We reveal our valuation summary below and think investors should attempt to value Netflix through a DCF model to get a feel for its lofty valuation, even after price declines following its recent disappointing results.
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Source: Valuentum Securities, Inc.
Note that our upside case in the table is the upside scenario of our exceedingly optimistic base-case assumptions that result in the $189 fair value estimate outlined above. In other words, our base-case fair value in the table above already represent an exceedingly bullish upside scenario for Netflix.