Are Netflix, Amazon And Research In Motion Cheap?

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 |  Includes: AMZN, BBRY, NFLX
by: Value Research

Now that Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), and Research In Motion (RIMM) shares have dropped precipitously, investors are interested in whether these price declines offer the opportunity to buy stocks at a discount to their value. Exercise caution: as always, buyer beware!

When expensive, glamour stocks fall from grace there is a temptation to buy. This is a temptation and possibly not a value buying opportunity because (in the absence of valuation calculations) this appearance is based on a cognitive bias called framing. Essentially, your brain is comparing the lower price with the older, higher price and recognizing that it is cheaper now than it was then.

So what? The stock is cheaper, but is it cheap enough to be a value play? First, we could investigate relative valuation metrics:

Ticker

P/E (ttm)

P/E (forward)

P/S (ttm)

P/B

AMZN

100.2

71.0

2.7

13.9

NFLX

18.1

12.6

2.4

18.7

RIMM

4.1

4.7

0.6

1.2

Click to enlarge


We can also estimate future returns, giving growth estimates a chance. An investor could consider how future growth would decrease the price-to-earnings ratio in the future, essentially betting that valuations will improve with earnings growth. The investor would be able to sell the stock for a profit only if buyers were willing to pay for the stock at reasonable multiples. However, if investor sentiment had soured, the investor would either have to hold the stock or take a loss.

We can model this process using a three-year holding period since above-average growth estimates are not reliable further out. A price-to-earnings multiple of 13 is a little lower than the historical market average, and is conservative for stocks with some growth prospects. Earnings growth over the holding period will be taken as the lesser of earnings growth over the last five years and earnings growth projected by analysts for the next five years. Using the smaller of the two will lead to conservative estimates. These growth rates are used to calculate terminal price-to-earnings ratios, that is, price paid today divided by earnings at the end of the holding period for each stock:

3 Years Growth

Ticker

g (past)

g (future)

Terminal P/E

Annualized Return

AMZN

44.6%

27.1%

48.82

-36%

NFLX

45.1%

31.4%

7.98

18%

RIMM

38.5%

9.2%

3.13

61%

Click to enlarge


At this point we can rule out Amazon as a value play, even in light of the recent price declines. Moreover, Amazon’s high valuations are assessed based on some of the company’s higest recorded earnings: this is not an anomalously high P/E multiple based on temporarily-depressed earnings. Instead, high earnings are simply not enough to justify even higher valuations.

In contrast, Netflix is starting to look attractive. Detractors might question whether the company has reached a turning point, citing a 800,000 drop in subscribers and a $6 million drop in net income in the third quarter of 2010. These are not alarming figures: the company still has 23.79 million subscribers and it drop in income is equal to the $6 million drop in net income experienced in the third quarter of 2010. In fact, the 2011 net income drop is less on a percentage basis the drop last year.

Research In Motion looks even more attractive. This stock has been so beat up that it could suffer -20% annual earnings decreases and have the same returns (given a 13 P/E multiple) as Netflix with its phenomenal growth estimates. Certainly, its performance has disappointed analysts. However, at today’s prices, RIMM’s future performance could be dismal and still afford exceptional stock returns.

Both Netflix and Research In Motion are worth additional diligence as investment candidates.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.