🍿📺Business Overview

🎯Key Metrics

Total: 5/17

• +2 ✅✅ Projected Operating Margin: 40.00%
• +0 ⚠️ Projected 5-Year Revenue CAGR: 9.00%
• +1 ✅ Last 5-Year ROIC: 19.98%
• +1 ✅ Estimated Cost of Capital: 8.80% (less than ROIC)
• +1 ✅ Last 5-Year Shares Outstanding CAGR: -0.95%
• +1 ✅ Projected 5-Year EPS CAGR: 15.91%
• +0 ⚠️ Projected 5-Year Dividend CAGR: N/A
• +1 ✅ Moody’s Rating: A2
• -1 ❌ Morningstar Moat: Narrow
• -1 ❌ Morningstar Uncertainty: High

Netflix has become synonymous with watching movies. Its ever-growing catalog of movies and series locks in its users creating a business that has very high margins. It has been steadily growing its revenue and EPS at solid rates. It’s also worth noting that its Return on Invested Capital (ROIC) is greater than its estimated cost of capital (almost double) showing the company is growing its capital efficiently and making good investments over that same capital.

However, there could be some clouds in the future for Netflix. Despite its market leader position, the Morningstar Narrow Moat and High Uncertainty ratings reflect the fierce competition within the streaming business with big players like Amazon (Prime Video) and Disney (Disney Plus), as well as the future uncertainty on how AI may impact this business.

The metrics above take into account the current situation of the business and my own assumptions for the future of Netflix, that I will proceed to explain in more detail below.

As a little disclaimer before jumping into the “awesome” valuation fire, I normally use these key metrics as an “allocation helper” to manage my investment portfolio, however take all of this with a grain of salt, and do as you see fit. Feel free to override and change some of the assumptions I’ll make during the valuation, and as with anything please take responsibility for your own investment decisions.

📈Business Valuation

Before presenting you the final valuation, I will show you first my own assumptions, as well as the historical data and analyst projections that led to that.

Revenue Growth

Below is the last ~10 years of revenue growth for Netflix:

The guidance from management for 2026 is around ~12-14% and analysts are projecting a decline into ~9-11% for the next couple of years after that reaching single digit territory by 2030.

💡My assumption is that Netflix will be able to grow its revenues ~12-15% on Year 1 and ~8-12% during Year 2-5.

Cost of Capital

I’ve used the latest quarterly and annual reports of the company, the 10-Year US bonds as the risk free rate and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity. Also, given the fact that Moody’s provided a rating for the company I used it as the debt rating.

Cost of Capital: 8.80%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I’ve used: Cost of Capital – The Fair Value Journal. It is and will ever be completely free 🙂

Also, keep in mind that the average cost of capital in the US for a company similar to Netflix in the Entertainment industry is ~7.13%.

💡My assumption for the cost of capital is that it would remain above the industry average, given that Netflix is riskier than the average business in the Entertainment field, given its tech background. For simplicity I’ve set it to the estimated value of 8.80% from end-to-end.

Later, we will explore some variability over these values by using the Monte Carlo simulations, exploring for example if Netflix becomes a more traditional company and converging to the entertainment industry averages or if it will increase its cost of capital by becoming a higher-focused tech company.

Operating Margin

Below is the operating margin for the company, during the last couple of years:

There’s a clear upwards trend, the company is clearly expanding its margins, increasing them ~10% in just 5 years.

💡My assumption is that Netflix will continue its margin expansion and will be aided by the introduction of AI into its movie making and movie recommendation processes. I believe that it will start at ~30% already in 2026 and will eventually expand into ~40% territory. As always, we will allow for some value exploration and variability during the Monte Carlo simulations.

Sales / Capital ratio (Reinvestment)

This ratio shows you how the capital invested is being translated into the business revenues. Please remember that sometimes the company may invest today to only reap the benefits and sales after a couple of years.

Below you can see the last 5 years of Sales to Capital ratio for Netflix:

The company is really taking advantage on past investments into the business. Also it is clear to see that this ratio is also still expanding.

💡I believe Netflix will still see its Sales to Capital ratio increase given the reduced need of reinvestments into the business with the introduction of AI into its movie making and recommendation systems, optimizing their creation process. I’m assuming an expansion from 1.3-1.45 into 1.4-2 (the upper end would be if Netflix becomes even more of a capital light business than it is today, with the introduction of AI for example).

ROIC

Still related with the company’s reinvestments, but this time with their return on the capital invested.

This ratio has also been expanding over the last couple of years:

Well above the estimated cost of capital for the company, it seems that it will continue its expansion.

💡My assumption is that the company will still be able to return above its cost of capital long-term. I will have it converge to a ROIC of ~15%, however we will explore in the Monte Carlo simulations a scenario where Netflix converges to the industry cost of capital ~7.13% (losing all competitive advantages) and in the higher end to a ~20% (exploring a more efficient and tech-focused business).

Discounted Cash Flows (Weight: 60%)

I’ve used the latest annual report and my assumptions explained above to complete my Discounted Cash Flow valuation:

Some notes on the inputs above:

• Terminal Revenue Growth – I’m using the risk-free rate (10-Yr bonds of the US), because long term the company should not grow more than the rate of the economy. I’m using the risk-free rate as a proxy to it, so the terminal growth becomes it;
• Initial and Terminal Tax Rate – Given the fact that its recent averages are around ~18% I’m assuming the same value for both.

All the other inputs were taken from the financial statements or from my assumptions.

The DCF gives us an estimated fair value of 86.58 dollars for Netflix.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used my assumptions and the range explained on during those sections.

As you can see from the above Netflix seems to be undervalued given that its current price of 71 dollars is around P10. From these simulations we can extrapolate that there’s ~90% probability of Netflix being undervalued and ~10% of being overvalued.

Please feel free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF – The Fair Value Journal

EPS Growth (Weight: 40%)

For the EPS valuation, I designed three different scenarios, to be used later on the Monte Carlo simulation: a bad, a base and a good scenario. Everything about them is explained below. These scenarios also take into account the assumptions we discussed earlier.

Please note that the latest, Trailing Twelve Months (TTM), EPS for Netflix is $3.23.

Also some relevant historical notes about the company:

Revenue Growth (CAGR)

💡 This was discussed earlier, but analysts are projecting a tapering down into single digit territory in 5 years.

Shares Outstanding (CAGR)

💡 The policy for Netflix has been buying back shares, namely recently with the depressed share price. I believe this will continue moving further even if reducing the rate a little bit.

Net Profit Margin (Average)

💡 As we discussed before for the Operating Margin and Sales/Capital ratio, this value has been expanding and it will continue to probably expand as well.

P/E ratio (Average)

💡 The current P/E ratio for Netflix is 22, well below its historical values. This is normal given the move into a more mature state of the business. However I believe the company deserves a higher PE than the current one.

Knowing this, these were my three scenarios for the next 5 years:

Bad Scenario

• Revenue Growth (CAGR): 8.00%
• Net Profit Margin (Average): 26.00%
• Shares Outstanding (CAGR): -0.50%
• P/E ratio: 20
• EPS 5th Year: $5.20
• EPS CAGR: 10.01%

Base Scenario

• Revenue Growth (CAGR): 10.00%
• Net Profit Margin (Average): 30.00%
• Shares Outstanding (CAGR): -1.00%
• P/E ratio: 25
• EPS 5th Year: $6.76
• EPS CAGR: 15.91%

Good Scenario

• Revenue Growth (CAGR): 12.00%
• Net Profit Margin (Average): 34.00%
• Shares Outstanding (CAGR): -1.50%
• P/E ratio: 30
• EPS 5th Year: $8.60
• EPS CAGR: 21.63%

Given these assumptions, based on the historical data, I filled in and valued the company using the EPS Growth projections, discounted by the estimated cost of capital previously calculated and using the assumptions of the base scenario.

Then again, I used the Monte Carlo simulations to explore the possibilities on the lower (bad scenario) and on the higher (good scenario) end.

From this valuation, Netflix looks undervalued given that its current price of 71 dollars is well below the P10. We can extrapolate that there’s more than ~90% probability of the company being undervalued given this valuation method.

As before, feel free to try this yourself: EPS Growth – The Fair Value Journal

EPS Scenario Returns

We can also explore a little further the different scenarios by projecting in time the bad, the base and the good case scenarios.

Feel free to try this yourself: EPS Scenario Returns — The Fair Value Journal

✍️Summary

Now that we did all the heavy work, let’s take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, but for me I would start adding again or initiating a position in Netflix below the 86.76 dollars mark, because I believe, despite all the fear mongering nowadays relating with AI, that this company will be one of those that will take advantage of it, to optimize its content creation processes. Also, because I believe that Netflix is in a great position to expand its business in the entertainment industry to more business segments if needed.

Please, as always, remember that the fair value estimate has a 100% probability of being wrong and it will never be a precise number, even if it has decimals next to it 😮

Overall it seems Netflix is undervalued at its current market price.

Fair Value: 98.71 dollars.