Why did I go with Netflix? Their current movie selection in Canada is actually very, very limited, but I started my 1-month free trial offer anyway, because they offered streaming to PCs and my PS3. So, I can watch movies anywhere I want as long as I had access to a PC and an internet connection. That sealed the deal for me. In the US, Netflix has begun to roll out a streaming only plan for subscribers. The movie selection in the States is superior to that of Canada. I was willing to bite the bullet and spend $7.99/month just to have the convenience of streaming videos. To date, I've watched about 20 movies since I started my trial in October. That's less than $1/movie...granted, I could've probably borrowed the same movies from the library for free, but the convenience justifies the nominal fee. I can't wait for Netflix to improve their selection. At that point, it'd be a no-brainer for anyone to subscribe to it.
In light of this, Netflix has become a very hot stock! In one year, the stock has risen from about $50 to $184. Can this fantastic growth continue? Let's find out!
In Figure 1, you will see that it takes Netflix 2.8 years to pay off its current debt using the free cash flow from last year. We'll call this a pass. It's ok for a company to carry debt, just as it is ok for you to have a mortgage. However, it's much preferred if the company can finance its growth with earnings and not debt. What this shows is that the operating margin of Netflix is probably not that good. Otherwise, money would be pouring in and it would not need to borrow cash to grow its business. A quick check at Yahoo Finance shows a 12.85% operating margin. Although there's no hard and fast rule how much this should be, I personally like it to be at least 20% to show that the business has a true moat (i.e. they can charge the customer a high price for their product). For comparison sake, Apple (Ticker: AAPL) has an operating margin of 28%, Google (Ticker: GOOG) 36%, Coach (Ticker: COH) 32%.
Netflix currently has little competition in the streaming arena. The company that comes closest is Hulu.com. However, the content is considerably different. Hulu focuses on TV shows and has a very limited selection of movies (even worse than that of Netflix Canada). Apple TV and Amazon also has streaming content but are on a pay-per-view basis, although their content is better. Youtube may become Netflix's biggest threat; Google recently announced that it was planning to offer free premium content from the biggest studios. On the DVD rental front, Blockbuster is going down (in bankruptcy protection). Redbox is the only real competitor at $1/rental/night. But my guess is Netflix will eventually go all streaming and drop its DVD rentals. All-in-all, I think Netflix has a pretty good position going forward. As we noted, its operating margins are pretty thin and if any competitor figures out a good assault on Netflix, it could be in trouble.
Netflix gets a 7 out of 10 from me for Moat.
This section is all about margin of safety. With a P/E ratio of 56, you have little room for error. You want to be conservative in your estimates and have a margin of safety. When you have both, you really have a good margin of safety! Therefore, I would rate Netflix as a risky investment right now. It gets a 4 out of 10 for MOS.
You can also see his intelligence from his trades. In the past 12 months, he has sold $40 million worth of Netflix stock! He still has about 1.2 million indirect shares, which is worth about $220 million now. As you can see, as the stock rose to lofty levels, he slowly offloaded his shares, locking in some gains. He knows that the valuation of the stock at P/E ratio of 70 is probably a little high. With 1.2 million shares still at stake, I believe Hastings has a good reason to run the company well. His recent sale does not show disloyalty to the company, but rather, Hastings' prudent management of his finances.
I give Hastings an 8 out of 10 for his Management.
Are there any red flags with Netflix in terms of ethics? Probably. Let's dissect the business a little bit. Netflix rents movies to viewers. What could go wrong there? That was a rhetorical question! If you're thinking R-rated movies, you've hit the nail on the head. There are quite a number of questionable movies on Netflix, especially with some of the more sexually explicit and/or violent films. Of course, there's no X-rated movies on Netflix, but some of the R-rated stuff are still pretty unnerving. Although the USCCB's investment policy is not to invest in companies whose significant portions of revenues derive from X-rated films, this is still a somewhat problematic area.
Aside from this, there wasn't much dirt to dig up with Netflix. They get a 7 out of 10 for Meaning.