Introduction
Successful companies have for a long time relied on the adaptation to changing times including the organizations' reinvention for the sake of achieving their objectives. Among these companies is Netflix, an American company that started out by delivering DVDs by mail and has since then grown into a first-mover in the video-streaming industry. Part of the success of Netflix is owed to its share price history as it boasts of a strong stock price with an IPO amounting up to 8,000% since 2002 (Petkova, 2018). The company also owes its success to the lined up contracts with main content producers. With the continuously increasing number of online subscribers, Netflix has gained it's name as one of the most competitive companies in the industry. However, Netflix earned its share of losses in 2011 when its CEO, Reed Hastings, proposed the idea of splitting the organization into two different companies, losing the support of the main shareholders. Such doldrums may be a threat to the delivery of superior returns to the company's shareholders.
In addition, there has been an unending debate on whether or not Netflix is overvalued. While some financial experts focus on the subscriber number as the basis of the company's value, others focus on the company's profits and revenue. Moreover, some financial experts claim that the company's losses could interfere with its success in the near future. In line with this, there is a need for a technical analysis of the common stock of Netflix using the common indicators as discussed in this paper. The paper also presents an analysis of Netflix Inc.'s enterprise value and the EV-to-EBITDA ratio while explaining the implication of the company's valuation. Relying on information provided by the Netflix 10K Report, Netflix Inc.'s valuation ratios over five will be analyzed and the indicators used to rate the wholesome value of this online streaming company.
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Analysis
The first indicator that can be used to analyze the value of the stock for Netflix is its earnings per share. Earnings per share are the representation of part of a company's total earnings set aside for each share of common stock. According to the data presented in the company’s form 10K, Netflix’s earnings per share has been fluctuating from 2013 to 2015 with 2013 having an EPS of 0.28, it went up in 2014 to 0.63 and down again in 2015 to 0.29. However, for the last three years, the company’s EPS has shown a steady growth which projects a positive outlook in the future. From having an EPS of 0.29 in 2015, the company improved its performance in 2016 to having and EPS of 0.44 and lastly registered an EPS of 1.29 in 2017. A steady EPS is able to indicate whether a company is doing well and will do well in the future. From the analysis, Netflix will be doing well in the future judging from the steady growth of EPS in the last three years.
The price/earnings ratio provides a measure of the relationship between a company's earnings and its stock price. One can tell whether a company is overvalued or undervalued by looking at whether the stock price is low or high compared to the company's earnings. The company’s price/earnings ratio is over the past five years has been extremely high compared to its peers. In 2013 it had a P/E ratio of 190.42 which dropped to 77.5 in 2014 then rose sharply to 377.51 in 2015 and lastly dropped in the last two years to 286.67 and 151.55 in 2016 and 2017 respectively. Netflix is highly over valued compared to its peers like McCormick which has a PE ratio of 16.96, Campbell with 17.31, General Mills with 18.74 and Heinz with 15.83.
The price-to-earnings-growth (PEG) ratio is a more appropriate ratio in comparing the PE ratio of companies with different growth rates. This is because a high PE would make a company to seem overvalued when in essence it has a high growth rate than its peers. According to NASDAQ analyst research (NASDAQ Website, 2018) , Netflix is expected to grow its earnings an at annual average growth rate of 30%. According to PEG ratio, Netflix is overvalued since it has ratios as high as 5. Compared to its peers, there is no tradeoff between the costs associated with acquiring the company’s stocks and the values of growth. Therefore, the stock is unreasonably valued given the expected growth rate in its earnings.
The price to book (P/B) value ratio is an indicator of whether the company’s stocks are overvalued or undervalued. If the market value is higher than the book value, this could be an indicator that investors expect high returns from the stocks and hence are willing to pay a high amount. However, if the market value is higher than the book value but the company has a low return on equity, this is an indicator that the company’s stocks are overvalued. Netflix has had a very high price to book ratio over the past five years but with low earnings compared to its peers. This goes to show that its shares are overvalued.
The dividend payout ratio (DPR) measures the value of dividends a company distributes out to its investors. Netflix currently has a dividend payout ratio of 0.00%, indicating that the company is a high growth company. This low payout ratio is an indication that the company has more room to increase its dividends in the future.However, this may be compromise the current position of the company among its competitors as a high dividend payout ratio positively reflects in an organization's performance.
The dividend yield, used to measure the returns on dividend as a ratio of a company's stock price, is also useful in providing a valuation of Netflix Inc. Since the company pays out no dividends then the dividend yield is 0% as well. While returns from dividends highly contribute to the total returns produced by a company's equity securities, companies with reinvested dividends generate more wealth than companies relying solely on capital gains. Therefore, Netflix could be on the verge of being overtaken by its key competitors with high dividend yields. The low dividend yield of Netflix Inc., however, indicates that the company still has room for increased dividends in the future.
A company's enterprise value is viewed as its speculative takeover price which is more widespread than the market capitalization. Enterprise value is usually calculated as the company's market cap plus the debt and the minority interest and preferred shares, minus the total cash, cash equivalents, and the marketable securities. On the other hand, EV-to-EBITDA ratio is derived from the division of the enterprise value by its EBITDA (Vugec et al., 2018). The EV-to-EBIT is derived by dividing a company's enterprise value by its EBIT. The enterprise value of Netflix Inc. as of today is $155,869 million with EBIT of $1,605 million as at September 2018. Therefore, the current EV/EBITDA ratio is 97.09. Based on the 2017 10K report, Netflix Inc. enterprise value of 86,870 million in the fiscal year ended December 2017. The enterprise value was calculated using the formula below, represented in millions, and comprises data derived from the 10K report:
Market cap ( 84,715.20) + preferred stock (0) + long-term debt ( 9,964.00 ) + current value of long-term debt (0) + minority interest (0) – Cash and cash equivalents ( 2,823.00)
= 91,856.20 million
From the above analysis, the positive enterprise value of Netflix Inc. is an indication of the company's high value. However, the value of the company may be compromised in the near future due to the increased long-term loans and failure of the Netflix to payout its dividends. Based on the indicators discussed in this section, it is clear that Netflix Inc. is overvalued. Such high value may be attributed to the company's contracts and the number of online subscription it enjoys know addition to the indicators that have been extensively discussed in this paper.
Conclusion
The technical analysis based on the indicators provided in the 10K report shows that Netflix might be one of the most overvalued stocks in the market today. However, the company has to grow its revenue by a quarter of its current price for it to remain relevant in the market over for the next two decades. Despite the rising competition in the online streaming industry, Netflix has experienced enormous growth and profitability potential going forward. This is as evident in the ratios that have been presented and discussed in this paper. Considering all the variables, the enterprise value of Netflix has the potential to go much higher in the future. However, the main determinant for the future success of Netflix lies in the number of subscribers and not the revenues, profits and cash burn. For the purpose of increasing the company's worth, it would be best to increase the reinvested dividends as this presents a major difference between a company and its competitors.
References
Bughin, J., & Manyika, J. (2018). Measuring the full impact of digital capital.
Damodaran, A. (2018). Going to Pieces: Valuing Users, Subscribers and Customers.
DeCovny, S. (2018). Assessing Value in the Digital Economy. CFA Institute Magazine , 29 (1), 12-14.
Petkova, I. (2018). Introduction: Field Transformations and Institutional Entrepreneurship in Cultural Industries. In Engineering Legitimacy (pp. 1-16). Palgrave Macmillan, Cham.
Vugec, D. S., Spremić, M., & Bach, M. P. (2018). Integrating Digital Transformation Strategies into Firms: Values, Routes and Best Practice Examples. In Management and Technological Challenges in the Digital Age (pp. 119-140). CRC Press.
NASDAQ Website . (2018, November 3). Retrieved from Netflix, Inc. Analyst Forecasts Earnings Growth: https://www.nasdaq.com/symbol/nflx/earnings-growth
