When nearly half of businesses in the United States have price-to-earnings (or “P / E”) ratios below 18x, you might consider Netflix, Inc. (NASDAQ: NFLX) as a stock to be avoided entirely with its P / E ratio of 62.3x.
When looking at P / E ratios sometimes there is a rationale for the high value, other times it is simply overconfidence of investors.
Here, we’ll take a look at Netflix’s P / E, compare it to industry and market, and see if this is a warranted valuation metric.
Investors should also be aware that sometimes traders can use a “sell the news” strategy after the results are announced, and use the higher volume to sell a larger position. This is why P / E can be a good metric to consider before profits.
In the graph below, we can see how Netflix’s P / E compares to the market and the industry.
Check out our latest analysis for Netflix
As we can see from the chart above, Netflix’s P / E is well above the levels of the US entertainment industry (43x P / E) and the market (18.8x). The boom in the industry may be associated with the recent increase in streaming service subscriptions and the rollout of new infrastructure by companies deploying 5G services.
Most importantly, we must ask ourselves: “Is Netflix past the high growth phase?“For companies, this marks a period when the P / E shifts from an indicator of investor sentiment to an appropriate measure of stock performance.
In this regard, we can observe that Netflix has been profitable for some time and has recently generated positive free cash flow. While it is true that the business continues to grow, the rate of revenue growth has slowed over the past 12 months and competitors have stepped up their streaming business.
Maybe now is a good time to start seeing Netflix as a stabilizing business and also rate it on a P / E basis.
Want a full picture of analyst estimates for the business? Then our free Netflix report will help you find out what’s on the horizon.
What do the growth indicators tell us about the high P / E?
To justify its P / E ratio, Netflix would need to produce exceptional growth well above that of the market.
In retrospect, last year generated an exceptional 67% gain on the company’s bottom line.
The last three-year period also saw an excellent overall increase of 449% in EPS, helped by its short-term performance. Therefore, it is fair to say that profit growth has recently been superb for the company.
As for the outlook, the next three years are expected to generate growth of 28% per year according to estimates from analysts watching the company. This promises to be significantly higher than the forecast for growth of 14% per year for the market as a whole.
With this information, we can see why Netflix is trading at such a high P / E relative to the market.
Even if investors want high growth, the effect of the same growth rates can be seen in a limiting sense by some investors who hold larger positions and may decide to change course on their investment strategy. This is why investors should be aware that there may be a different kind of sentiment for Netflix in the future.
So far, however, shareholders are unwilling to get rid of something that potentially envisions a more prosperous future.
Key points to remember
It is argued that the price / earnings ratio is a lower measure of value in some industries, but it can be a powerful indicator of corporate sentiment.
Investors should also be aware that good news is not always necessarily a long signal before a call for profits.
As investors, it is important to decide when look at a company from the perspective of earnings performance as a relevant indicator for action. This will help avoid surprises and improve risk management along the way.
Currently, Netflix can be seen both as a high growth company where value for money does not yet matter, or as a stabilizing company which should also be assessed as such.
If investors consider Netflix to be still a high-growth stock that has most of its growth prospects to come, then it’s premature to factor in the P / E. However, if we see the company stabilizing, a P / E of 62.3x may be of concern to investors.
You always have to think about the risks. Concrete example, we have spotted 1 warning sign for Netflix you must be aware.
If these risks make you reconsider your opinion on Netflix, explore our interactive list of high-quality stocks to get a feel for what’s out there.
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Simply Wall St analyst Goran Damchevski and Simply Wall St have no positions in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents.
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