One of the hot stocks over the last few years has been Netflix. Clearly, the product has been extremely successful across the globe, as the company has experienced strong subscriber growth. As of July of this year, the stock was already up 40% for the year. Despite the success of the product and the stock, profits have never been a big part of the Netflix story. The company has always spent a tremendous amount of money, including substantial debt-funded content acquisitions, and has yet to really turn the corner into strong profits.
In July, the company lost its rights to air “The Office.” Many of these older shows such as “Friends” and “Seinfeld” are still important to subscribers. I’d argue more importantly, other companies such as Disney, AT&T, and NBC are unveiling their own subscription services. These companies have very strong content libraries and are creating pricing pressure for both content acquisition, and how much they can charge subscribers. This is a major problem for Netflix, as the bull case seemed to imply that the company would continually be able to raise prices on a continuously growing subscriber base.
Since July, the stock has dropped by about 33%, giving up all its gains for the year. Despite the decline, the stock is still extremely expensive by every financial metric. It currently trades at roughly 7 times sales, a P/E of 102.4, and an EV/EBITDA of 62.7. Stocks will fluctuate and a selloff can create opportunity, perhaps Netflix will do well from here. The problem is that it still offers no margin of safety whatsoever, which is the big difference between this type of investing and what we practice with deep value investing.
Netflix is just one of many stocks that trade with little regard to actual financial fundamentals. Their strong performance over the last few years have helped propel this bull market, beyond what many would have expected. Nearly everyone invested in these types of securities believes that they can time their exit appropriately, while riding the waves higher. This is rarely the case though, as timing the market is usually not a profitable endeavor.
One of the benefits of value investing is that, when a stock trading at a discount to intrinsic value drops management often takes advantage of the opportunity by buying back their own stock. This increases our ownership of the company at attractive prices, and buybacks done at a discount to intrinsic value, actually increase the intrinsic value of the remaining shares. We have benefited from this equation numerous times over the years with many of our largest investments, most notably in financial stocks. There is major divergence between the relative valuations of glamour stocks such as Netflix and the stocks we own, and this should be a source of some comfort as we move forward into more challenging future conditions.