Not Buying the Netflix Euphoria

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Shareholders of Netflix (NASDAQ: NFLX) were treated to a pleasant surprise on January 23, when the company reported fiscal fourth-quarter and full-year financial results.  The company turned a profit of 13 cents per share, a shock to many as analyst expectations were for a loss of the same amount.  Upon releasing results, shares of Netflix soared after-hours—and haven’t stopped rising since then.  I’ve used Netflix’s services before and I enjoy the company’s services.  However, at its current valuation, I can’t join the sense of euphoria in the wake of the company’s results.

Hype in Perspective

On the plus side, Netflix reported revenues of $945 million during the quarter, which also beat analyst expectations.  The company’s first quarter earnings guidance was also received positively, with the company projecting earnings per share in a range of zero to 23 cents per share.  Expectations for the first quarter were for a loss of 7 cents per share.

While these numbers were better than expectations, I’m a value investor in the classic sense.  I don’t want to pay too much for a company’s earnings, no matter what the market reaction might be.  The market cheered Netflix’s results and sent the stock soaring, but valuation still matters (which I’ll get to later).  On the other hand, Netflix’s peers Time Warner (NYSE: TWX) and Disney (NYSE: DIS) trade for much more reasonable multiples.  Time Warner and Disney trade for trailing price-to-earnings ratios of 18 and 17.5, respectively.

In addition, both Time Warner and Disney offer their investors a dividend.  Disney has raised its dividend 16% compounded annually over the last five years.  Likewise, Time Warner increased its dividend 11% when it released results on February 6, and now yields 2.2%.  In addition, the company authorized a new $4 billion stock buyback program.

Investors were also pleased with Netflix’s rate of subscriber growth.  Netflix announced that it expanded its number of U.S.-based subscribers by 2.05 million during the quarter and 5.48 million during 2012.  Netflix now has more than 27 million subscribers in the United States and more than 6 million international subscribers.  Netflix has done a solid job gaining subscribers, but Time Warner CEO Jeff Bewkes was quick to point out on his conference call that his company’s HBO premium channel has 114 million subscribers globally, which is about four times Netflix's subscriber base.

The Bottom Line

Since Netflix released earnings, the stock has soared from under $100 per share to its current level north of $180 per share.  The company now enjoys a market capitalization of over $10 billion.  These numbers are certainly exciting, but a dose of perspective is needed here:  the company earned exactly 31 cents per share in fiscal 2012.  That means the company is trading at a trailing price-to-earnings ratio of 580 times.  But surely, Netflix bulls will contend, the company is on the precipice of spectacular growth that will expand the “E” in the formula to therefore shrink the multiple to more acceptable levels.

While that is always possible, I just don’t see it happening.  Since 2008, the most profitable year for the firm was fiscal 2011 when the company earned $4.28 per share.  At its current price, the company would still be trading for more than 40 times those earnings.  The fact is, the company would have to grow earnings at such an eye-popping rate to justify its current valuation that I can’t bring myself to buy the stock, and would advise most investors to do the same.

Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Netflix and Walt Disney. The Motley Fool owns shares of Netflix and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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