Netflix (NFLX) is one of the worldâ€™s leading providers of DVD rental and video streaming services. The company has operations in the United States, Canada, as well as Central and South America. The company, with its headquarters in Los Gatos, Calif., more than 4000 employees worldwide.
As of Sep 28 close, Netflix stock was trading at $127 with a 52-week range of $125 â€“ $304.79. It has a market cap of $6.68 billion. Trailing twelve month P/E ratio is 32.2, and forward P/E ratio is 19.3. P/B, P/S, and P/CF ratios stand at 19.9, 2.6, and 20.1, respectively. The 3-year annualized revenue and EPS growth stand at 21.5% and 45.1%, respectively. Operating margin is 13.8%, and net profit margin is 8%. The company has a debt-to-equity ratio of 0.7. Netflix does not have a dividend policy yet.
Netflix has a 3-star rating from Morningstar. While its trailing P/E ratio is 32.2, it has a 5-year average P/E ratio of 34.8. Out of 32 analysts covering the company, 9 have buy, 2 have outperform, 15 have hold, and 3 have underperform, and 3 have sell ratings. Wall Street has diverse opinions on Netflixâ€™s future. The bottom line is -9.5% growth, whereas the top-line growth estimate is 119% for the next year. Average five-year annualized growth forecast estimate is 33%.
What is the fair value of Netflix given the forecast estimates? In this article, the 27th in the series, I will show a step-by-step calculation of Netflixâ€™s fair value using discounted earnings plus equity model.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E_{0} + E_{1}_{ }/(1+r) + E_{2}_{ }/(1+r)^{2} + E_{3}/(1+r)^{3} + E_{4}/(1+r)^{4} + E_{5}/(1+r)^{5}^{ }+ Disposal Value
V = E_{0} + E_{0}_{ }(1+g)/(1+r) + E_{0}(1+g)^{2}/(1+r)^{2} + â€¦ + E_{0}(1+g)^{5}/(1+r)^{5} + E_{0}(1+g)^{5}/[r(1+r)^{5}]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E_{0}(1+g)^{5}/[r(1+r)^{5}] = E_{5} / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.
Netflixâ€™s Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.
Since we are in the middle of the year, it will be more feasible to take the average of ttm EPS of $3.95 along with the mean estimate of $6.67 for the next year.
E_{0}_{ }= EPS = ($3.95 + $6.67) / 2 = $5.31
Wall Street holds diversified opinions on Netflixâ€™s future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 33%. Book value per share is $6.35.
The rest is as follows:
Fair Value Estimator | ||
V0 | E_{0 } | $5.31 |
V1 | E_{0 }(1+g)/(1+r) | $6.36 |
V2 | E_{0}((1+g)/(1+r))^{2} | $7.62 |
V3 | E_{0}((1+g)/(1+r))^{3} | $9.13 |
V4 | E_{0}((1+g)/(1+r))^{4} | $10.94 |
V5 | E_{0}((1+g)/(1+r))^{5} | $13.11 |
D | E_{0}(1+g)^{5}/[r(1+r)^{5}] | $119.22 |
BV | Equals | $6.35 |
Fair Value Range | Lower Boundary | $171.71 |
Upper Boundary | $178.06 | |
Potential | 40.20% |
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for Netflix is between $171.7 and $178 per share.
As of Sep 29, Netflix was trading at a price of $127. I like Netflix as a company. While the recent price hike was not welcome, the company still has a strong customer base. I still see a great growth potential, as well. The market over-reacted to the recent events. The current price of $127 is way below the lower boundary of my fair-value range. The stock has 40.20% upside potential to reach the upper boundary of its fair-value range.
Summary
Netflixâ€™s stock has always been priced at a premium due to its high growth potential. The average P/E ratio in the last 5 years was 34.8. As of September 29, the stock is trading with a P/E ratio of 32, and a forward P/E ratio of 19.3. In the last 5 years, annualized EPS growth was 11.81%. With an increasing presence outside the U.S., I expect the growth to keep its pace.
As of Sep 29, Netflix was trading at $127, way below my fair-value range of $171.71 and $178.06. The stock has risky debt/equity ratio of 0.7, but it has a low Beta of 0.7. The stock has 40.20% upside potential based on 33% EPS growth estimate. Analysts are also pretty bullish on the stock. The mean intermediate-term target price estimate is $212, implying significant upside potential. The stock is trading almost 58% lower than its 52-week high. I was bearish on Netflix in April, when the stock was trading at P/E ratio of 73. At that time, its price of $250 was way above my fair-value range. However, the recent sell off created a nifty entry point. With an O-Metrix score of 6.21, I expect Netflix to be an out-performer in the long-term.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.