In March 2016, I published an update on Netflix (NASDAQ:NFLX) with the conclusion that the stock was likely headed higher, even as Wall Street expectations were quite high. The piece, entitled "Is It Too Late to Get Long Netflix Stock?" attempted to present the argument that bears on the company were justifying their negative view based on current revenue and earnings, which was clearly the wrong way to analyze the stock.
A year later, it does appear that most people understand that, while the streaming business is very competitive, Netflix has a lead both domestically and internationally, both of which are unlikely to be squandered. In a recent interview, media legend, Barry Diller, supported such a view, saying that he didn't see how anyone could catch them in terms of global scale.
Over the last year, this view has clearly been adopted by more and more investors. As the bears capitulate, it provides a tailwind for high-growth companies like Netflix. Given the U.S. economy's low expansion rate, growth investors specifically tend to target well-known stocks that are fundamentally in strong positions from a competitive standpoint.
While this is a very rational development, and Netflix is positioned beautifully from a strategic standpoint, it does not mean that people can lose sight of valuation. With the stock hovering around $140 per share, Netflix sports an equity market value of $60 billion, which seems to be out of step with the actual financial results of the company.
To illustrate why Netflix's current stock price doesn't make sense, we have to take a close look at subscriber counts and cost structure. Since Netflix has only one revenue source - monthly subscription fees - it is fairly easy to model the company's financials and determine what subscriber levels the current stock price is baking in.
So, let's determine exactly what the share price suggests in terms of Netflix's subscriber base. Below is a chart that shows various valuation scenarios for Netflix, a key assumption being that it achieves net profit margins of 18% (this is not a random figure, it is based on the company's own long-term 40% contribution margin objective, and calculated by deducting 13% for corporate and R&D expenses, and another 9% for taxes).
Netflix just reported a 2016 year-end subscriber count of 90 million and its core offering right now is priced at $10/month. As you can see, the current stock price reflects roughly 120 million subscribers at $13/month, assuming a P/E ratio of 18x.
Even with aggressive subscriber growth over the next several years, the stock appears to be at least two years ahead of itself in terms of the underlying business and its inherent profitability. As a result, it is difficult to justify the run the stock has had in the last year (simply because of the speed at which it has gotten to this level).
Accordingly, I have sold the last of my personal shares. Given the stock's volatile nature, there could very well be better entry points in the future, but the current price looks a bit frothy.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.