Netflix, Inc. (ticker: NFLX), the world’s premier streaming video service, is almost single-handedly responsible for changing the way people consume modern-day movies and TV. So it’s no coincidence that the Netflix stock price has gone bonkers in recent years.
The company that became a household name by mailing you DVDs is now a cultural phenomenon, bringing you your favorite movie and TV offerings in a matter of milliseconds, not business days. Due to its first-mover advantage, Netflix dominates the streaming TV market.
But does its early lead spell continued success for NFLX stock, or has the epic run-up of its share price been too aggressive?
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To answer that question, it’s best to look at both sides of the coin: here are five pros and five cons to buying Netflix stock.
Pro #1: Subscriber growth. It’s no surprise that subscription-based business models rely on subscriber growth to increase revenue. Other than raising subscription prices, that’s the only way to grow the top line. Luckily for NFLX shareholders, Netflix is doing both, with standard subscription prices now at $9.99 a month, up from $7.99 a few years ago.
Despite that headwind, Netflix added 3.57 million members globally in the third quarter of 2016, trouncing the 2.3 million members the company expected to add.
According to Michael Kramer, a portfolio manager on Covestor and founder of Mott Capital Management in Garden City, New York, kids growing up today on Netflix will remain loyal to the model.
“Give a 5-year-old two options: every cable TV channel created or one subscription to NFLX. After the first commercial on TV the child will switch to NFLX and never go back,” Kramer says. “The on-demand generation is here and they will reshape the way we consume content forever.”
Con #1: Sky-high valuation. While Netflix stock’s most compelling catalyst is its strong growth, that’s precisely why it hasn’t been ignored by Wall Street. The company’s expectation-topping numbers have only led to a meteoric valuation. A price around $120/share values Netflix at around $50 billion. It also means shares trade for more than 120 times projected 2017 earnings, a multiple that will require astronomical earnings growth in the coming years to justify.
Pro #2: Downloadable content. Subscribers can now download their favorite shows and movies on their mobile devices, which is a huge win for customers. By downloading content, customers can enjoy Netflix even without an internet connection, and will also be able to avoid going over network data limits far more easily. While not all content is available for download, this feature dramatically increases the utility of a Netflix subscription.
Con #2: Losing luster as takeover target. In short, Netflix’s unusual success is precisely the reason its stock price is unusually high. One obvious consequence of a rapidly rising stock price is lower demand from both Wall Street and Main Street investors, while another, potentially more ominous consequence is that Netflix has become less attractive as a takeover target. Cable industry heavyweights like Comcast Corp. ( CMCSA), Verizon Communications ( VZ), AT&T ( T) and Walt Disney Co. ( DIS) all have motive to acquire NFLX, but a price tag of $50 billion or more appears prohibitive even for these players.
Pro #3: International expansion. With nearly 50 million domestic subscribers, Netflix has already conquered the U.S. Global domination is next on the list, with the real growth opportunities all overseas. In January 2016, Netflix entered 130 new countries in a massive global rollout. Efforts to “localize” content that’s custom-made for certain regions, languages and cultures are paying off; international subscribers grew by 31 percent in the first three quarters of 2016.
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Con #3: Increasing competition. The central force bringing innovation in capitalistic societies is competition, and Netflix’s success has attracted plenty of that. Most notable is Amazon.com ( AMZN), whose Prime Video service comes with the annual $99 Amazon Prime subscription. Hulu and HBO are also increasingly popular streaming options, and as the field becomes more crowded, Netflix’s first-mover advantage will erode.
Pro #4: Great management team. Reed Hastings has become one of the iconic CEOs in Silicon Valley, and like many iconic technology CEOs, he has a different way of thinking. That brain of his has led to enormous wealth creation for shareholders, and as the company’s founder, investors can be sure their interests are aligned with the CEO’s.
Con #4: Content costs. In the long-term, what differentiates Netflix from its competition will be its content, and more specifically, its original content. And quality content doesn’t just grow on trees. With original programming increasing from 600 hours in 2016 to more than 1,000 hours in 2017, Netflix will increase content spending by about $1 billion to $6 billion annually. As content creators increasingly mull creating their own streaming services, they may charge more to license their own content to Netflix as well.
Pro #5: Strong programming. The old phrase, “you gotta spend money to make money” is on full display with NFLX. Yes, soaring content costs are perhaps Netflix investors’ biggest concern, but that lack of frugality also makes the Netflix portfolio so unique.
“Netflix is aware of its leadership position in original content production,” says K C Ma, professor of finance at Stetson University. “Third-quarter 2016 results blew away all expectations and guidance. The company credited the beats to new original content, specifically the second season of ‘Narcos’ and the debut season of ‘Stranger Things.’ It’s the high front-end cash investment that makes this high quality programming possible.”
At the end of the day, it’s this quality programming that makes subscriber growth and retention so impressive.
Con #5: Potential Amazon deal with HBO. There’s chatter that Amazon is working on a deal to give Prime members discounts on HBO Now subscriptions, something that could hurt NFLX in two ways. Not only would it be a boon to Amazon and HBO, it could foreshadow a closer relationship between Amazon and AT&T, which is acquiring HBO parent Time Warner ( TWX). Specifically, it could allow Amazon to pay lower fees to AT&T for fast internet speed, or even allow AT&T’s wireless customers to stream Amazon without racking up data fees, a privilege Netflix pays for.
At the end of the day, figuring out the best stocks to buy for 2017 and beyond is no easy task. Risk tolerance, portfolio size, investor age and willingness to research all have to be taken into consideration.
[Read: 7 Best Tech Stocks to Buy for 2017.]
Deciding whether Netflix shares are right for you is a personal decision. But for most investors, the ratio of risk-to-reward — especially as NFLX trades for well over 100 times forward earnings — simply isn’t favorable.
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Pros and Cons of Buying Netflix, Inc. (NFLX) Stock originally appeared on usnews.com
