Overvalued: Netflix (NFLX)
I'd like to borrow $8.22 billion dollars, but it's going to take me roughly 40 years to pay it back
. Would that be a deal you'd be willing to make? If it is, please email me! Otherwise, keep reading
Today, Blockbuster filed for bankruptcy and has left the market, for a short while at least, wide open to companies like Netflix. Netflix, subsequently, has moved to a brand new 52 week high of $156.93 per share.
All this from a company that has a net profit margin of 7.27%, return on equity of 54.63%, and earnings per share estimate of $3.74 for 2011. If you don't know my style yet, let's go over the key points of any investment.
#1 Return To Investor. This is the estimation of profits a company will earn in the next 5 to 10 years based on their brand, business model, history of success, and future prospects. The best way to estimate this is to take a historical growth rate and discount it against a tax-free financial instrument like a Treasury bond, or S&P 500 index fund. I usually think about what it would mean if I bought the entire business, as opposed to just the price of the stock.
In the case of Netflix, if you purchased the entire business, you would start receiving an annual payment of roughly $200 million. Compared to the $8.32 billion you paid, this number seems very small doesn't it? In fact, it's less than 2.5%.
#2 Payback Period. All industrial companies understand the payback principle for every dollar they spend on equipment. The same holds true when you invest in stocks.
In the case of NFLX, based on forward earnings, the company has a 40 year payback period. That's longer than any home owners mortgage and at a much lower rate. So, would you buy a business that would take 40 years to pay you back?
I would not, however, in the stock market even companies like this have the possibility to go higher based on the activities of investors. This happens whether the stock is worth the price or not.
#3 Never Short Stock. I personally do not like shorting stocks and never advocate it to anyone I work with. The main reason, as stated above, is that a company's stock could continue to appreciate despite it being worth a lot less.
As with Netflix, you should pass over stocks that have earnings yields that are very low and payback periods that are very long.
We'll let the NFLX trade play out, but one possible outcome is that they continue to earn more and more money, but the price flattens. This happened with Google for 2 years and it's likely to be the same story in NFLX. We are not going to address the real business of Netflix that is still under intense pressure from services like OnDemand and RedBox, but that still doesn't matter based on the numbers. Like one of my favorite artists would say "Men Lie, Women Lie, Numbers Don't."
So, keep that in mind when you put your hard earned money to work.
Overvalued: Netflix (NFLX)
By: Jonathan Poland
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