Buying Netflix shares today is crazy. Why? Because it costs him fortunes to generate his own content and he has more and more competitors, such as Disney, Amazon and Apple.
It’s true: with Covid, the company gained 15.8 million customers in the first quarter and an estimated 7 million new customers in the second quarter. But there are many top competitors who will take away some of their market share. Read the note to the end and I will tell you all the details.
The streaming industry is changing dramatically.
For many years, Netflix enjoyed almost alone leading the industry, but now more and more companies are starting to conquer this market with their own streaming services, including giants like Amazon, Disney and Apple.
In recent months, Netflix has increased its sales as people stayed at home to follow the quarantine. But this will not be forever. The company itself took care to clarify that the situation was temporary in its latest earnings report.
Netflix will have a hard time continuing to increase its sales at the rate it did before, when the pandemic passes.
But there is something else: Many of Netflix̵
That’s why the company had to make a radical change: before Netflix played third-party content, it now became its own content generator.
And this has a huge impact on your numbers. As the cost of producing content is much higher than passing on existing content.
For the sake of clarity, I’ll show you the Netflix Free Cash Flow chart (the winnings you will be able to hand out). You can see how the last two years almost $ 3,000 million were negative:
Remember that the only way for a company to cover the deficit is with debt, and Netflix’s total debt in the second quarter of 2020 amounts to USD 16,000 million.
This colossal increase in negative free cash flow is explained by the expensive generation of proprietary content that you have to pay in advance to then generate profits over time through subscriptions.
In the streaming industry today, it is not just about getting people to hire the service but getting them to continue choosing it because the costs of switching to the competition are very low.
In a nutshell, A company of flow can melt faster than BlockbusteIt is enough that you have an uninteresting offer of content or that the competition has a better proposal for people to cancel their subscription.
And while the quarantine favored Netflix in terms of subscriber growth, it did the same with its competitors. For example, Disney + was launched in November 2019 and so far has a quarter of Netflix subscribers. In just two months, it went from 25 to 54 million. And Amazon Prime Video already has more than 150 million subscribers.
Just look at how the US market is changing:
It is worth clarifying: it measures are expensive, does not mean they can not continue to rise and become even more expensive. But if someone is considering buying for a 2 or 3 year horizon, I think they are wrong.
How do we know if Netflix shares are expensive? Let us see:
There are two metrics commonly used to measure whether a business is expensive or cheap: Price to revenue or “P / E” ratio (Price on sale) and Price to sale or “P / S” ratio (Price on sale). The first says how much the market is willing to pay for the PROFITS that a company has. The other the same but with respect to its SALE.
Netflix has a price / revenue ratio of 105. Is this expensive or cheap?
To be able to answer, we must compare it with something. Take the S & P500 Index (an index that measures the 500 largest companies in the US stock market).
The S & P500’s P / E is currently over 27, and its historical average is 15.
What does this mean?
On the one hand, the valuations in the stock market are far above their historical average.
And when it comes to Netflix, which has a very high P / E. And that means the market expects the company’s earnings to continue to grow at a staggering pace in the immediate future.
But the most impressive thing is what happens to Price to Sales. In the following graph, I show you the value of this relationship for Netflix today and what you see is that for every dollar the company SELLS, people are willing to pay almost 11:
To make it very clear: anyone who buys a Netflix share today pays in advance for ten years of corporate turnover.
And to compare that with the market, this ratio for the S & P500 is 2.3 (and its historical average is in the 1.5 zone).
So, the question that arises is: Are market expectations about Netflix’s future reasonable?
As we saw earlier, the current industry’s current answer makes a resounding no.
Netflix faces a dual problem: the loss of content and the increase in competitors. However, its share price does not reflect this reality. And one thing is for sure: as soon as sales fall, the Netflix price will fall very sharply.