3 Reasons Netflix, Inc. (NFLX) Is Overvalued

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Netflix, Inc. (NASDAQ:NFLX) remains overvalued even after undergoing a 7-for-1 stock split last year. Low-profit margin, low cash flows, and poor starts in some countries are some of the problems that continue to evoke serious concerns about the stock’s valuation. Insiders have been selling the stock in the recent past, amidst growing concerns about the stock’s valuation.

The streaming giant is currently valued are 393x its 2015 earnings. Its net margin stands at 1.8% given that the company only made $122.64 million on revenues of $6.8 billion last year. A majority of stocks in the S&P 500 sell for about 20x earnings something that should come into play ones Netflix matures in the streaming business.

For Netflix, Inc. (NASDAQ:NFLX) to sell at 20x earnings, it will have to grow revenues to about $133 billion. It is highly unlikely the company will attain this feat given the unending problems it continues to face on subscriber growth, cash flow, and economies of scale.

Concerns over Subscriber Growth

Domestic subscriber growth has hit a wall, forcing the streaming giant to pursue new opportunities abroad. Given the level of competition back at home and abroad, the company is unlikely to continue growing robustly as more cable companies launch their own streaming services.

Netflix currently boasts of 74.8 million subscribers. If it is to generate $133 billion in revenue to trade at 20 X earnings, it will have to reach about 1.35 billion subscribers. With earth’s population currently at about 7.125 billion, the company will have to sign up at least 18.9% of the total human population. That is the only way it will be able to attain P/E ratio of 20 at the current stock price. However, that is unlikely to happen given that the company is currently servicing the needs of just 1% of the Earth’s population.

Netflix, Inc. (NASDAQ:NFLX) is already making strides to bolster its subscription base. Aggressive expansion abroad has seen the service makes its debut in New Zealand, Japan and Australia. The expansion drive has also come with its fair share of problems, arousing further concerns about the stock’s valuation.

Profit margins have been the most affected because of the international expansion push. International margin’s in 2015 stood at -17.1%. Industry experts remain skeptical about the same turning positive in the near future. Focus on growth in unprofitable markets should continue pilling valuation concerns on the stock, going forward.

Terrible Cash Flow Metrics

Another indication that Netflix, Inc. (NASDAQ:NFLX) is highly overvalued is the fact that it has terrible cash flow metrics. Over the past five years, the company has been forced to borrow money from stakeholders. Operating activities have failed to generate sufficient cash to sustain expansion drive.

The company currently has about $6.1 billion in contract expenses set to mature soon. The big question now is whether the amount will ever be paid and how.

The stock is currently trading as if cash flows will grow faster than the revenue. That will not be the case given that Netflix, Inc. (NASDAQ:NFLX) is currently trying to build its own original shows, which should eat into cash flows going forward.

Since 2010, content expenses have increased by about 43%, faster than revenues that have only grown by 25%. Long term, the amount Netflix owes on content could outpace revenue generated from the said content; sinking the company into further debt.

Economies OF Scale Deficiency

Contract expenses will continue to increase as long as Netflix, Inc. (NASDAQ:NFLX) is in business even though it continues to benefit from economies of scale on content. The company could be forced to produce custom content for different foreign markets a move that could significantly affect any scale advantages.

Bidding wars also continue to put more pressure on the stock’s valuation given that the same goes a long way to drive costs.

Bottom Line

The reality of the matter is that Netflix is expanding into unprofitable areas and facing competition both at home and abroad. The rate at which it is burning cash all in the effort of maintaining an edge in the business should continue to evoke valuation concerns.

Netflix, Inc. (NASDAQ:NFLX) will have to address the raised concerns if its share price is to move from current levels that seem highly overpriced. Any stock price increase that comes into play will be seen as negative as long as the company does not provide tangible solutions to the hurdles at hand.

Viraj Shah

Viraj Shah has completed M.Com (Finance) and is currently pursuing his CFP. He tracks US markets along with other global markets like India very closely. He is very passionate about stocks, real estate, and technology. He also believes that money can always be made in the market.

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