Netflix Analysis

After yesterday (11/22)’s news that Netflix is introducing streaming service in US for $8/month I feel the need to study the stock more carefully. It’s supposed to be priced in already but the stock still soar up 8%. I think Netflix is such a good example that valuation sometimes really doesn’t matter. It has PE around 70 now after a great run since latest earning release. Till last quarter (9/30/2010) Netflix has 16.9 million subscribers! 

(collected from quarterly and annual statements)

In the above graph you can see the total subscriber of Netflix is increasing pretty much linearly over the past six quarters: ~ 1.3 Million per quarter. These are the people stick with Netflix so far. If you look at the gross subscription addition graph you can see the fresh addition subscription is ~3.1 Million every quarter.  And the trend is up. In the same graph you can see the acquisition cost per subscriber is trending down which is mainly due to the increasing subscriber number and relative stable marketing expense. With this high level of subscription, the churn rate is stable: around 4% and paid subscriber is around 94% (however, it is showing downward trend. Not a big deal as you see the growth of gross subscriber addition and decrease of acquisition cost.) R&D spending is also quite stable: ~7.3% of revenue. What is concerning is the average revenue per subscriber per month. It is obviously showing a downward trend. The main reason for that is the increase of “low end” subscription and decrease of “high end” subscription. Product mix shift will continue as Netflix introduces the streaming services. On the other hand, it can be compensated by lower cost since Netflix will eventually eliminate the DVD mailing service which is more costly than online streaming.

How about Netflix’s financial health in our ratios’ term? It definitely has sound financial ratios. I list the quarterly ratios and some of yearly data for your reference. You should be able to see most of the lines are showing upward trend.

Now let’s take a look at Netflix’s historical earnings and stock prices. Interestingly enough, as EPS increases linearly its stock price is exploding exponentially. This surely demonstrates the enthusiasm of investors. Can the price be justified? I don’t think so. But again, valuation doesn’t matter here. I think investors for Netflix are focusing on subscribers and some relevant cost only.

I’d like to do a little reality check here. US has population of 310.7 Million and average number people per household is about 4~5. So let’s use 4.5 people per household then I estimate there are 69 million households in US. Let’s say with Netflix’s super first-mover advantage it can have a market share of 80% (like IntelJ), which gives us 55 million. Netflix already has 17 million so there are only 38 million left. If Netflix is adding 1.3 million subscribers per quarter it will take Netflix 29 quarters, ~7 years to have all these customers. In the meantime, average monthly revenue per customer will decrease gradually due to the product mix shifting to low price service and intense competitions from Hulu, Apple, Google, and Amazon. It may eventually just have one price for all services to compete. Going a little extreme here, if the price is about $8 per month per subscriber, the total revenue for Netflix in 7 years will be 55 million * 8*12=5.28 billion. Only about three times what it has now (1.67 billion). Well, if Netflix is really doing well and keeps current $12 level. The revenue in 7 years will be 7.9 billion. Assuming profit margin stays around 7% then the earnings is about 7.9*7%=553 million (five times 2009 earnings). To simplify my estimation, from there I will say Netflix will be a large cap with steady cash flow but not much growth and it will give out all the earnings as dividend to investors ( using current number: 55 million). So at that point (7 years later), the stock price should be (553/55)/7% (discount rate: simple WACC calculation): ~$143. This is the price after 7 years within this 7 years you can still discount some earnings to the present day plus the discounted value of the year 7 price. However you do it I couldn't get around $190.

Of course, we all know that Netflix just initiated streaming service in Canada. International expansion can be the further growth catalyst. But it’s hard for me to imagine Netflix can go to other countries and expect to gain main market share easily. In addition, as internet distribution of TV/movie contents become more and more popular the competition is gonna be brutal. Not only distributors like Amazon, walmart, Apple, and Google will try harder, the content providers have to figure out way to make more money through more channels. The key competitive advantage for Netflix is the broad contents and first mover advantage. How long will those last is a question. For example, if Apple is going with subscription model and push for collaborations with content providers, it could potentially beat up Netflix and Hulu easily as it has popular iphone/ipad platform to get people use Itunes. Or if internet TV such as Google TV catchs up main stream and they can provide easy delivery of contents and Netflix may not be the best choice any more. (I do think this will take a while)

Again, all above are just my own current opinion. Netflix might transform into other sort of media firms which can justify its stock price before its growth slows down. I don’t know but I’ll keep close eye on it since Netflix is such an interesting growth stock.

I'll conclude with analysts opinion stats and let's see how high the market can take Netflix to.

S&P 500 and US dollar index

The negative correlation between S&P 500 and US dollar index is super strong.

Johnson & Johnson (JNJ)'s financial ratios --- Peer comparison

Four other companies' ratios are compared with JNJ. These four are Pfizer, Eli Lily, Abbot, and Norvartis. It appears that Eli Lily performs the best while Pfizer did the worst. Well, for choosing your stock you need to do more homework than just ratio comparison. Outlook is the key.

Johnson & Johnson (JNJ)'s financial ratios

Johnson & Johnson is engaged in the research and development, manufacture and sale of a range of products in the health care field. The Company operates in three business segments: Consumer, Pharmaceutical, and Medical Devices and Diagnostics.


It's a dividend play company and good one to diversify your retirement portfolio in my opinion. I'll list some of the financial ratios below (esp. for Tao). Seems to me people care about its profitability the most since there is not much change in efficiency anyway. (In JNJ's earning report they don't even bother put out balance sheet) In order to understand the company's potential you will want to dig into the segmental data they include in their financial statements. In addition, you also need to know the product pipeline, expiration of patents etc. 

some thoughts on Chinese ADRs

It's amazing to see how frequently some Chinese ADRs got investigated for accounting fraud. If there are real fraud what were the auditing firms (IPO time) for these firms doing? Shame on them. Most recent ones are RINO, ONP, FUQI. They all have unbelievable growth if judging from their accounting numbers. I did look at ONP before by reading 10K and calculate financial ratios. The inventory turnover is crazily higher than all chinese peers and US ones (5 to 10 times higher). And the company borrowed money from CEO, etc. All kinds of strange stuff. I have to wonder who would want to be the investors on these stock. Probably at this stage only day traders are left in play.

This is common for other foreign ADRs as well. I would say find the ones making sense and don't believe in too good to be true numbers.

BTW, the market has another down day. And people think S&P500 will go down to 1165 then bounce back up; it's the 50 day moving average. It will be a 5% correction then. It's amazing to see how the market trades technically among the past few months. Is it really the high frequency trading effect?

Cisco's latest earning report

A not bad earning but very bad outlook. As Cisco beat both revenue and earnings their guidance for next quarter is far below expectations. http://www.reuters.com/finance/stocks/keyDevelopments?rpc=66&symbol=CSCO.O&timestamp=20101111023000

“Cisco Systems, Inc. announced that for fiscal 2011, it expects annual revenue to grow in the range of 9% to 12% on a year-over-year basis. For the second quarter of 2011, it expects revenue to be in the range of 3% to 5% on a year-over-year basis and earnings-per-share (EPS) to be in the range of $0.32-$0.35 per share and GAAP EPS to be in the range of $0.08-$0.10 per share lower than the non-GAAP EPS. The Company reported revenues of $40.040 billion in fiscal 2010; revenues of $9.815 billion in the second quarter of 2010. According to Reuters Estimates, analysts were expecting the Company to report EPS of $0.42 on revenues of $11.083 billion for the second quarter of 2011; revenues of $45.279 billion for fiscal 2011. “

So there you have it, ~17% drop after the ER day. Has the fundamental changed? Probably not, Cisco is just getting large and hard to grow fast. Acquisition helps growth but as you might know the cost of acquisition is also usually high. Many times so called synergy never materialize. I believe it won’t be an exception for Cisco.  

For people don’t know Cisco, here is short intro from Google finance:

Description

Cisco Systems, Inc. designs, manufactures, and sells Internet protocol (IP)-based networking and other products related to the communications and information technology (IT) industry and provide services associated with these products and their use. The Company provides a line of products for transporting data, voice, and video within buildings, across campuses, and around the world. Its products are designed to transform how people connect, communicate, and collaborate. Its products are installed at enterprise businesses, public institutions, telecommunications companies, commercial businesses, and personal residences. The Company has five segments: United States and Canada, European Markets, Emerging Markets, Asia Pacific, and Japan. The Emerging Markets theater consists of Eastern Europe, Latin America, the Middle East and Africa, and Russia and the Commonwealth of Independent States. In September 2010, the Company acquired Arch Rock Corporation.

I really like the telecom concept and have been enjoying the Skype and such products. Communication is supposed to be easy. The trend as I see is on mobile communication: facetime etc.

 In theory, IT spending should pick up as economy slowly recover. But Cisco’s guidance told a different story. Let’s hope it’s a localized issue.

Now let’s take a look at how analyst view Cisco: pretty bearish lately.

How is the stock perform on earning report day? Not exciting at all.

Non-GAAP earnings: not good growth sign. (compare it with Amazon you’ll see what I mean sign of growth).

The stock of the company seems really stuck into a range if you look back five years. I don’t blame investors since I don’t think I want to own their stock even after 19% drop.

The quarterly financial key data is listed in next table.

A few points: bad margin trend, bad sale growth trend, and would be worse considering the guidance for next quarter. 

a bad week for S&P500

But you really shouldn't feel surprised as the market has run up for over 2 months. I think a correction of few percentage point is not a big deal since the Feds will keep pumping the money into the market. Considering all the money at sidelines and the policy changes in Asia the market should still have more new highs to go when money comes back to US equity market. In addition, if you have QE2 then you can have QE3 as long as Ben is around. When the economy holds up until the unemployment rate goes down further, everything will be fine.

SPX from Stockcharts.com

Everything was down on Friday.

Cisco's management outlook for next quarter certainly triggered some fear about the economy. But hey, isn't that why Feds put out QE2? 

Still, be aware of the market condition and focus on individual stocks is my practice. 

China Lodging Group, Limited (HTHT)

Since I'll be busy with housework for a while after closing I try to give my quick thoughts on HTHT.

Cuz it’s only listed in US for a short while so there are not much financial infos.

Here are a few key numbers for past five quarters: (margins are pretty good.)

The recent price action seems to be triggered by Ctrip. Ctrip.com lowered their 4^th quarterly sales a lot, roughly from 117 m to 80m so that analysts downgraded the stock.  I think that guidance might give the market a hint that the travel business in China for next quarter is not as bright as expected. If you look at the price chart for HTHT you’ll see at the end of July they raised the whole year revenue guidance which gave the stock a boost. Investors probably just think HTHT might also lower guidance for Q4 like CTRP.

So it looks like a group sell-off (CTRP, HMIN, HTHT) for the past few days. It might go down further before the earning release. On the bright side, when the earning announcement is due possibility of upside surprise is a little higher than downside as expectations has been lowered a lot. I’m guessing that the latest quarter should have good result but next one is not as great partly due to the end of Shanghai World Exhibit.  Since it’s a growth stock (high PE ratio), pay attention to revenue growth and maybe margin. As long as the slow growth trend does not continue the stock should be ok.

From technical analysis point of view if the 13 moving average goes below 50 moving average the price becomes bearish. But TA again is just probability play; only for reference.

Daily market summary

What an amazing run today; everything is up (except for dollar). I believe there are big part of short squeeze going on. QE2 starts to work right away: investors' confidence is up. Let's hope it can last long.

Liz Claiborne Inc.(LIZ) earning report

I didn't know this stock until a friend mentioned. It reported earning this morning and had a great run so far. Here is the release. http://www.lizclaiborneinc.com/web/guest/pressreleases Liz Claiborne, Inc., incorporated in January 1976, designs and markets a global portfolio of retail-based brands, including JUICY COUTURE, KATE SPADE, LUCKY BRAND and MEXX. It is apparently a financially stressed company and the trading on this stock is volatile. 

Looks like investors (maybe I should say traders) like the narrowed lost. Based on the release you can see the adjusted loss is around -0.04 (Non-GAAP measure again) which is indeed much less than before.( see from the ER EPS graph). Even from the GAAP number you still can tell the profitability improvement (quarterly earning summary). The sales is picking up as well which shows the reversing downward trend. Investors certainly hope that continues. Well, considering the holiday season, they might get what they want on LIZ.

Quarterly earning summary

Financial ratio analysis (Margin looks good, efficiency is alright, but the liquidity and leverage ratios are still bad)

However, LIZ's equity keeps shrinking as it lost money for past two years. I would assume they will have higher borrowing cost which will negatively impact the profit. In order to dig deeper on the stock, some sort of monthly retail report might be worth the money.

Financial Ratio Analysis - peer comparison

Without peer comparison the financial ratio analysis can not be complete. What I'm showing you here are five companies' ratios side by side. The five companies are Amazon, Ebay, Walmart, Costco, and Overstock. Pay attention to Amazon and Walmart. As I mentioned in previous post, these two firms really show similar profitability and efficiency performance.  I really found this framework helpful to compare competitors. (Note: don't just assume the best company will have the best price action in the future)

Blackboard Inc.(BBBB) earning report

http://www.blackboard.com/Company/Media-Center/Press-Releases.aspx?releaseid=1491354

BBBB is a good business but current economic situation could keep negatively impact its business. Most of universities are cutting budget so the growth won't be high for a while. Currently the stock is priced as a high growth stock if you simply look at its PE ratio (67). A great company like Amazon just has that level of PE but with a much bigger potential as I see it.

The new quarter report is just alright since everything is inline with forecast. No wonder there is not much action in after-hours. Here are analysts' opinion and key ratio trend summary for those of you interested in BBBB.

Skilled Healthcare Group, Inc. (SKH), latest earning report -- Stats & Financial ratios

ER stats for SKH. It seems the momentum is still going today. Be careful. I'm not recommending stock here because I believe people should make their own decisions based on their own analysis. In addition, to invest in low price stocks you have to be ready to take big loss and you have to watch the fundamentals very closely.

Analysts' view (EPS & Revenue beat, and better management outlook guidance)

 ratio analysis: note here the data is GAAP standard.

Notice here both the analyst estimate and actual EPS results are in Non-GAAP term. What does that mean? GAAP is US standard for financial statement reporting so US firms (To be exact, firms listed in US) have to report GAAP data. Some firms want to show something else not reflected/disguised in GAAP so they will report Non-GAAP data. SKH is doing this to demonstrate their core operating results without the legal charges (non-recurring) etc. If you believe the company’s fundamentals are not influenced by the non-recurring items you should be fine to judge the performance by NON-GAAP numbers. Similarly in the report, EBIDA and such (management’s performance metrics here) are mentioned and explained. You might want to read that. It's a good measure for free cash flow of a company. All else being equal, good free cash flow is definitely a good thing.  

Skilled Healthcare Group, Inc. (SKH), latest earning report

Release is here: http://finance.yahoo.com/news/Skilled-Healthcare-Group-prnews-1535240150.html?x=0&.v=1. It has 21% run today after the better number and outlook.

You probably never heard of this one before. It’s in the healthcare sector, long term care industry. This is one stock I’m having for a long shot. Right now it’s in the low price category (<$5) and it’s really volatile. The reason I picked this one is due to the dramatic sell-off a while ago. I wished I had picked it up right after the sell-off. 

The sell-off is due to lawsuit payment: over 600 million which was eventually reduced to ~54 million. What is the lawsuit about? Simply put, SKH didn’t have enough nurses to take care of the patients/residents they accommodate. It’s actually an industry norm as I see since I had some first hand experience with nursing home companies. There are always not enough personnel as facility managers have to watch their labor cost very closely. They will let nurses go home early if resident census goes down. This is happening on a daily basis. Most of the nurses are working on hourly salary and they don’t get paid as well as those in hospitals; then the turnover ratios are scarily high—over 70%. For a nurse to stay in a nursing home facility he/she does have to gain pride in what he/she does. Good management is the key.

It is a challenging industry but also rewarding one. Most of time, Medicare, Medicaid, etc get the patients covered and the money is from Government. As long as the company has experts who know the regulation well and evaluate patients/residents well the revenue is guaranteed. Normally for a well-managed nursing home the cash flow is great. Think about the baby boomers in the States and people do get old and ill. In 20 or 30 years, the demand for nursing home service could explode.

As you read the Skilled Healthcare Group’s report, there are a few points you might want to pay special attention: medicare mix, skilled mix, occupancy rate, and also the revenue per patient day by type. These factors normally tell the health of the company. You know, you want high revenue potential patients so people on medicare is better than Medicaid. You want all the beds be filled so high occupancy rate is desirable. Skilled nursing care brings more revenue than other non-acute services so high skilled mix is good for the company. And so on. These are true for other long-term care firms too. I'll post SKH's earning stats and ratios tomorrow. 

Financial Ratio Analysis (Liquidity ratios and leverage ratios)

Liquidity ratios are about how solvent a firm’s assets can be. Naively put: If the firm is trouble, eg. Short of cash, how quickly can they sell their assets and get cash to get by. There are current ratio, quick ratio (main difference here is there is no inventory for quick ratio). Account payable is a good measure too since if you can postpone your payment to others you have more flexibility. I remember when I looked at Palm’s AP turnover I did see the change as the firm started to get stressed. You know, when a firm is in good shape, the suppliers won’t be too eager to collect their money as long as within reasonable time frame. However, when a firm is in stress, everybody want their money back as soon as possible. (same concept as a bank run, I assume) Some of the liquidity ratios are as follows:

Current ratio                             Current assets / current liabilities

Quick ratio                                (Cash + short-term investments + A/R) / current liabilities

Interest coverage ratio              (Net income + tax expense + interest expense) / interest expense

A/P turnover (times)                 Cost of good sold / average accounts payable

Leverage Ratios represent how the management utilizes capital. I always have trouble reading company’s report saying they’re raising equity while there almost no debt on the balance sheet. Small chinese companies tends to do. Don’t invest on them. Trading them can be dangerous too. Of course we all know, debt level needs to be  balanced. Many issues need to be considered: tax shield, interest coverage, etc. Two important leverage ratios are as follows:

Capital structure leverage       Average total assets / average shareholders’ equity

Long-term debt ratio               Long-term liabilities / total assets

Amazon as the example: liquidity ratios---

It’s interesting to see there is a dip for current ratio in 12/31/09 quarter. Can you guess why? Remember when I discussed the efficiency ratios, Amazon had a great quarter on 12/31/09 and its sales turnover is great and inventory turnover as well. That’s why: not much inventory left. You see, this is how the whole financial analysis framework keeps its integrity.

Leverage’s power can be easily seen from ROE vs ROA. We can simply assume ROE=ROA*Capital structure leverage. So, Amazon has 2 times asset to equity then ROE is two times of ROA. That simple.

Alright, now we should have gone over all the key ratios and let’s look at the framework once again as a whole. Again, it’s like an X-ray for a firm. When you evaluate a company you have to look at all perspectives and ratio analysis is the easiest way to dissect information. After you analyze one company you can compare with its peers eventually; then you might be able to say you have a good feeling about your company if data speaks good things about it.

Note: good financial ratios and trends don't warrant higher stock price since the market might have price in  all the future growth. Although, it does may you feel comfortable when investing a stock with sound fundamentals. In addition, if you are patient enough to get in a good stock with enough "margin of safety" it would be better.

People always wondering what is a stock really worth. Great question but a really hard one to answer. Don't just listen to others for price target since different people might have different trading/investing time frame. I do try to valuate company interested me and I encourage you do your own. However, treat it as an art project rather science one. Challenge your assumptions as new information arrives all the time.

On the other hand, ratio analysis is sort of science project as numbers reveal great informations. You still need to incorporate financial statements, news, research reports, etc to understand the ratios better and make reasonable projections. Well, with some basic accounting intuition financial ratio analysis can really help you diagnosis your company's health. This post concludes the introductory series. Hope it makes sense.