Despite post-pandemic struggles, Netflix still sees strong returns
In the past few months, many of the winners of the At-Home Revolution are starting to see their glory days come to an end. As people move on with their lives away from their homes, all the things they spent their money on when cooped up inside are no longer needed.
One of those is Netflix (NFLX), a leading streaming service.
However, the market seems to be understating just how profitable Netflix is, even as it falls from its peak.
That’s why it showed up on our FA Alpha Screen. Its strong profitability, high growth, and low valuations make it an interesting name.
Investor Essentials Daily:
Tuesday FA Alpha 50
Powered by Valens Research
Winners of the At-Home Revolution saw tremendous returns thanks to the pandemic. When everyone was stuck inside, they started to spend more on things to stay busy.
But in the past six months, staggering amounts of wealth have been wiped out from some of those biggest winners.
One of the biggest losers has been the streaming behemoth Netflix (NFLX).
Its platform made it perfect for binge-watching in the worst days of the pandemic, and in recent years, it has started to accumulate countless awards for its original content.
But now that people can go out again, Netflix is starting to struggle. Last quarter the company lost subscribers for the first time in over ten years, and the oversaturated market with increasing competition certainly isn’t helping.
Its price peaked at $700 a share in November 2021. Now, it’s just above $170. That’s a 75% drop in just seven months.
Just because a stock drops a lot doesn’t mean it’s immediately a value name.
But in the case of Netflix, FA Alpha 50 highlights it might be.
As-reported metrics make it appear that since the firm pivoted to streaming about ten years ago, return on assets (“ROA”) hasn’t broken 10%.
In the past three years, it has risen only slightly, from 5% in 2019 to 9% in 2021.
For a subscription-based model, those lowly returns are disappointing.
At the same time, it seems growth has been slowing, leaving investors wondering if there’s much else Netflix can do, or if it has become just another streaming network.
However, Uniform metrics show a bit of a different picture.
We can see that despite a step down in ROA last year as the peak of COVID wore off, it was still at an impressive 26% in 2021.
Considering Netflix revolutionized the streaming industry, these returns seem much more appropriate.
In the same time period, Netflix doubled its asset base, showing us it’s positioning itself to continue to grow.
Yet, after the stock dropped, Uniform P/E fell to a low of 15x, despite being an above average performer with an ROA of 25%.
While the company is now feeling the effect of pulling forward a bunch of demand during the pandemic, Uniform ROA shows us that market expectations look much too pessimistic.
That’s why Netflix showed up on our FA Alpha 50 screen. Its strong ROA, impressive growth, and low valuations make it a compelling and interesting name.
Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.
Warren Buffett, for example, once said investors should “concentrate on the world of companies, not arcane accounting mathematics.”
Investors who neglect the very real issues with as-reported accounting can find themselves caught up investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.
The only true way to focus on the “world of companies,” as Buffett suggests investors do, is to present a clear picture of how a business operates, something that can only be done by adjusting financial statements to reflect the arbitrary nature of certain accounting rules that leave much to discretion.
The world’s best investors understand the need to make these adjustments, which allows them to focus not on picking out the most popular companies, but rather on looking for great names in sleepy areas that the market isn’t paying much attention to. From there, the goal is to then identify quality companies with significant growth potential at reasonable prices.
That’s exactly what we’ve set out to do with the FA Alpha, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.
This list has outperformed the market by 300 basis points per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.
See for yourself below.
To see the other 49 names on the list, click here.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research