Netflix - A Fundamental and Historical Valuation

🍿📺Business Overview

🎯Key Metrics

Total: 5/17

• +2 ✅✅ Projected Operating Margin: 38.13%
• +0 ⚠️ Projected 5-Year Revenue CAGR: 9.38%
• +1 ✅ Last 5-Year ROIC: 13.60%
• +1 ✅ Estimated Cost of Capital: 9.45% (less than ROIC)
• +1 ✅ Last 5-Year Shares Outstanding CAGR: -1.09%
• +1 ✅ Projected 5-Year EPS CAGR: 19.73%
• +0 ⚠️ Projected 5-Year Dividend CAGR: N/A
• +1 ✅ Moody's Rating: A3
• -1 ❌ Morningstar Moat: Narrow
• -1 ❌ Morningstar Uncertainty: High

Netflix has become synonymous with watching movies. Its ever-growing catalog of movies and series locks in its users creating a business that has very high margins. It has been steadily growing its revenue and EPS at solid rates. Its also worth noting that its Return on Invested Capital (ROIC) is greater than its estimated cost of capital, showing the company is growing its capital efficiently and making good investments over that same capital.

However, there could be some clouds in the future for Netflix. Despite its market leader position, the Morningstar Narrow Moat and High Uncertainty ratings reflect the fierce competition within the streaming business with big players like Amazon (Prime Video) and Disney (Disney Plus), for example.

Below we'll check whether the current valuation prices in these risks and at what value it makes sense to add the streaming king to our portfolios.

📈Business Valuation

To calculate the intrinsic value of the company I'll use multiple methods:

• Discounted Cash Flows (DCF) - Intrinsic value is estimated by projecting its free cash flows over the next 10 years and discounting them to present value using the estimated cost of capital;
• EPS Growth - the fair value is estimated by projected the Earnings Per Share CAGR for the next 5 Years and then, given its current and historic values of PE, come up with a PE for the 5th Year. This will give us its price 5 Years from now using the formula: Price = EPS x PE that we then discount using the estimated cost of capital;
• Historical P/E - we assume mean reversion to the historical P/E values;
• Historical P/B - we assume mean reversion to the historical P/B values;
• Historical P/S - we assume mean reversion to the historical P/S values;
• Historical EV/EBITDA - we assume mean reversion to the historical EV/EBITDA values.

I'll put more weight on the DCF and EPS methods and only then the historical ones. Given the ever-changing landscape of the world and the streaming business it seems unreasonable to assume a higher probability of mean reversion to the historical averages of the company.

Cost of Capital

I've used the latest annual financial statement of the company, the 10-Year US bonds as the risk free rate and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity. Also, given the fact that Moody's provided a rating for the company I used it as the debt rating.

Cost of Capital: 9.45%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I've used: Cost of Capital - The Fair Value Journal. It is and will ever be completely free :)

Discounted Cash Flows (Weight: 30%)

I've used the latest annual financial statement of the company, the analyst estimates for both revenue and margins and the cost of capital calculated previously.

Some notes on the inputs above:

• Terminal Revenue Growth - I'm using the risk-free rate (10-Yr bonds of US), because long term the company should not grow more than the rate of the economy. I'm using the risk-free rate as a proxy to it, so the terminal growth becomes it;
• Terminal Cost of Capital - I'm assuming that the company starts at the previously estimated cost of capital and then will converge gradually to the average cost of capital of its industry;
• Terminal Tax Rate - The company starts at around ~13-14% of tax rate and then gradually converges to this terminal rate, equal to the industry average;

All the other inputs were taken from the financial statement or from analyst projections.

The DCF gives us an estimated fair value of 62.62 dollars for Netflix.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used analysts estimates.

As you can see from the above Netflix seems to be overvalued given that its current price of 87.26 dollars is well above P90. From these simulations we can extrapolate that there's 90% probability that the stock is overvalued at the current price.

As always take this single output, from this DCF valuation method, with a grain of salt. Let's move on to the other valuation methods to get a clearer picture.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF - The Fair Value Journal

EPS Growth (Weight: 25%)

For this valuation method, I've used the current EPS and the analysts estimates of EPS growth. I also assumed a 30 PE for the company, so a little below its current averages.

Then again, I used the Monte Carlo simulations to check how the estimated fair value changed as my assumptions were modified.

Using this valuation method, Netflix that is currently priced at 87.26 dollars seems to be undervalued, being currently valued below P10. Given this, we can extrapolate that there's 90% probability of Netflix being undervalued.

This is basically a perfect mirror and inversion of the previous DCF output. That's exactly for this reason that we should always look at multiple valuation methods while valuing a company. Then, our common sense (or lack of it) will weigh each valuation method differently, taking the company and its industry into account, to reach a given fair value. It'll always be wrong but at least we tried 😢

Let's continue to the historical valuations and hope they bring us some clarity.

As before, feel free to try this yourself: EPS Growth - The Fair Value Journal

Historical P/S (Weight: 20%)

The current P/S (Price / Sales) ratio is above its 7-8 Year average. This means that the company is overvalued by this metric. Assuming a mean reversion to its historical average of 7.82 we can assume a fair value of 76.10 dollars.

For every type of historical and relative valuation you can use the same free tool: Historical / Relative Valuation - The Fair Value Journal

Historical P/E (Weight: 10%)

The current P/E (Price / Earnings) ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 62.25 (there's a low probability - it's very high) we can assume a fair value of 122.99 dollars.

Historical EV/EBITDA (Weight: 10%)

The current EV/EBITDA (Enterprise Value / Earnings Before Interests, Taxes, Depreciation and Amortization) ratio is above its 7-8 Year average. This means that the company is overvalued by this metric. Assuming a mean reversion to its historical average of 13.05 we can assume a fair value of 79.16 dollars.

Historical P/B (Weight: 5%)

The current P/B (Price / Book Value) ratio is below its 7-8 year average. This means that the company is undervalued or at least fairly valued by this metric.Assuming a mean reversion to its historical average of 15.93 we can assume a fair value of 95.81 dollars.

✍️Summary

Now that we did all the heavy work, let's take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, but for me I will pick a fair value of 79.39 because I believe Netflix can still widen its moat and experience greater margins improvement from AI.

Please, as always, remember that the fair value estimate has a 100% probability of being wrong and it will never be a precise number, even if it has decimals next to it 😮

However, overall, Netflix seems to be overvalued or at least slightly overvalued at its current valuation.

Fair Value: 79.39 dollars