Why Netflix Is a Great Stock

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On May 21, 2014 Netflix (NASDAQ: NFLX) announced its plans to expand to six European countries later this year. The trend-setting company plans to set up in Germany, France, Austria, Switzerland and Belgium. Netflix already has a foothold in the U.K., Ireland, Denmark, Finland, Norway and Sweden. Not bad considering it started the international campaign in 2010! 

A little bit about Netflix' international plan
The Company plans to gain the majority of its growth from its international segment. Netflix says that as long as the company as a whole is profitable, it will continue its aggressive international expansion.

So far the plan has been very successful. Between 2011 and 2012, the international subscriber base grew by a whopping 238%. Between 2012 and 2013 the base grew by 98%. The subscriber base is expected to increase dramatically in 2015 as its content acquisitions and marketing initiatives attract new customers. 

With all of this growth, it seems the company's  earnings should be more robust. But the reason earnings were lackluster in 2013 and are projected to be mediocre in 2014 is that the international expansion is extremely expensive. To attract new subscribers, the Company invests large amounts of capital into marketing and content acquisition in new regions. But once Netflix completes its international sprawl, the expenses will decrease and profits will rise. Netflix expects its international segment to enjoy an operating margin similar to its current domestic margin of 23%. Although this expansion will take a lot of time and resources, it's definitely worth it.

Well, what about competition?
Yes, there are competitors out there who would love to snag some market share. However, Netflix has a healthy lead when it comes to its subscriber base. This lead should enable Netflix to complete its international expansion before its competitors can even match its domestic streaming subscriber base.

The most obvious competitor of Netflix is Amazon.com (NASDAQ: AMZN). Amazon Prime is a well-known buffet style streaming content provider. Amazon claims it has at least 20 million Amazon Prime members. At the end of 2013, Netflix had over 30 million domestic streaming members. It's difficult to determine how much business Amazon has taken thus far. Its Prime service offers members free shipping on Amazon purchases. Also, research has shown that many consumers have both a Netflix and Amazon Prime membership. 

Netflix's recent success with original content is being mimicked by numerous companies. Yahoo! recently launched two original series that will be freely available on its website. The company also disclosed a partnership with Live Nation to stream concerts on its website. In contrast to Netflix, Yahoo! will rely strictly on revenue from advertisements that will play before its videos.

It's not what it looks like
Although dozens of competitors have entered the streaming-content market, it's nothing to be alarmed about. Unlike certain industries where the size of the market is essentially limited, the size of the streaming-video market has tremendous room for growth.

The main thing shareholders need to pay attention to is whether or not Netflix's competitors are able to distract customers from using Netflix. Since it seems to have the most sophisticated recommendation service and extensive content library, it seems its firm grasp on the streaming content industry will hold for the foreseeable future.  

So what's up with the crazy PE Ratios?
Okay, so Netflix is a great company, but is it overvalued? This is a tricky one. Netflix market capitalization is currently 144 times larger than its earnings from 2013 (PE is 144 times trailing earnings). The average PE in the Telecom industry is currently 30 times trailing earnings (average of 82 firms).

So what gives? The answer lies in something that was discussed earlier: once the company reaches maturity, its operating margins will increase and yield tremendous profit growth for shareholders. And remember, the trailing PE ratio is based on recent profit, not expected profit. Last year's earnings per share of a measly $1.93 hardly seem to justify a stock price of $400+, but remember, investing is all about the future, not the last twelve months. 

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The article Why Netflix Is a Great Stock originally appeared on Fool.com.

Michael Nielsen owns shares of Netflix. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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