Personal Finance

I Love Netflix, but I'm Avoiding the Stock for Now

A couple watching TV

Netflix (NASDAQ: NFLX) is a company that fundamentally altered the world. After changing how physical movie rentals were done, the company ushered in an all-new content distribution paradigm by moving to digital streaming. Today, all you need is a computer, internet connection, and a Netflix subscription to gain access to a whole host of movies and television shows.

Over time, the company's management team has made seemingly one brilliant move after another. For example, Netflix's business model can be fairly easily replicated if it only stuck to distributing content owned by others. So, in recent years, the company has been funding and rolling out exclusive content. Perhaps more importantly, that exclusive content is often very good, and a critical component to keeping customers locked into its platform. That lock-in not only ensures that customers stay subscribed, but it makes it easier for Netflix to raise prices over time.

A couple watching TV

Image source: Getty Images.

Netflix is a phenomenal business run by a management team that really knows what it's doing. With that being said, I wouldn't buy the stock right now. Here's why.

Netflix is richly valued

Netflix is great, but the stock already prices in a lot of greatness. As of this writing, the stock trades at $363 per share. That's not the highest it's been over the last 52 weeks, but it's nearly 60% higher than the 52-week low that it set about a year ago.

Now, the mere fact that a stock is performing well doesn't necessarily mean that the shares aren't worth buying (although I admit that I like to buy businesses that I really like when they're out of favor with Wall Street), but there are other signs that the stock might be overheated.

On several different valuation metrics, Netflix is very richly priced. According to analysts, Netflix is set to generate $4.05 in earnings per share (EPS) in 2019 and $6.43 per share in 2020. This means that the stock trades at just shy of 90 times 2019 EPS and a little more than 56 times 2020 EPS estimates.

If we focus on its price-to-sales ratio, the business trades at about 7.8 times the revenue that analysts expect Netflix to generate in 2019 and 6.3 times their 2020 estimates.

And, finally, if we peek at the company's free cash flow data, it has been burning cash for years, with the rate of that cash burn seemingly continuing to rise.

NFLX Free Cash Flow (TTM) data by YCharts .

Put simply, for Netflix to justify its current stock price, it'll need to keep dramatically growing its revenue and EPS for years to come. And, sooner or later, the company is going to need to become free-cash-flow positive.

Investor takeaway

To be clear, I'm not trying to make the argument that you should go out and sell your Netflix shares today nor am I saying that the stock is a short (no matter how richly valued a stock is, shorting on valuation alone tends not to be a successful strategy). Netflix is a great business that I expect to thrive in the years to come.

However, given that the stock is richly valued and has rallied so hard and fast over the last couple of months, now doesn't seem like a good time for new investors to jump into the stock or for current investors to add to their positions.

That being said, for those who do want to get in on Netflix, I wouldn't say that you should wait until the stock trades at a bargain-basement valuation, either -- Netflix is the kind of stock that's likely to command a rich valuation for the foreseeable future as it continues to deliver impressive growth.

Indeed, I'd be opportunistic in looking for an entry point. Perhaps an overall market pullback or a worse-than-expected quarterly report might drive the shares down, creating a better opportunity for investors with longer-term investment horizons.

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Ashraf Eassa has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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