Why the market is overpaying for Netflix stock ahead of earnings

Never fight the market, and remember that the trend is your friend. This is why Netflix (NASDAQ: NFLX) stock should be flashing across your watchlist today. The trend in this stock shows a definite bullish momentum, and the market is comfortable paying a premium to gain exposure to this name just as it is preparing to announce its quarterly earnings.

While you can feel comfortable in the fact that this stock could potentially break away from its 52-week highs on its recent path upward, a moment of caution could be introduced into your gameplan because a better potential purchase price could be presented before you know it, but more on that later.

If your appetite for big swings is at an all-time high, you can ignore the voice in the back of your head saying that all the growth the market expects from this stock could be potentially baked into the price today. After celebrating new all-time high prices, the NASDAQ index is having a big old party this week.

What’s the direction?

When you break down the price action, considering that the stock now trades at 96.0% of its 52-week high prices, the conclusion is that the market is definitely bidding the price up in the bullish sentiment. However, if stocks were picked based on this metric alone, there would be many more billionaires in this world.

To figure this out, you will need to use a market translator. Lucky for you, the homework has been done to get the market's pulse on Netflix. Building on the price action already mentioned, you can look at the stock's forward price-to-earnings ratio relative to competitors in the consumer discretionary space.

Warner Bros. Discovery (NASDAQ: WBD) and even Walt Disney (NYSE: DIS) are adding to the competitor names list as streaming platforms representing significant market share. Still, Netflix comes ahead for reasons that will become clear in just a bit.

The broadcasting industry trades at an average forward P/E of 6.8x today, a benchmark for you to compare Netflix and its competitors against. Starting with the leader itself, Netflix brings a 30.2x valuation multiple, representing a more than 300.0% premium to the peer group. Remember the saying, “It must be expensive for a reason.”

Even though it carries arguably the strongest brand moat and market penetration of all its peers, Disney stock still can’t command a premium valuation like Netflix did. Its 21.7x forward P/E multiple puts the name at a 200.0% premium to the sector but not high enough to beat Netflix.

Last but not least, Warner Bros. is a bit of a wild card. Despite famous investor Michael Burry, yes, the guy from the big short who called the 2008 financial crisis, buying the stock, there is a big gap that needs to be filled if it even is to compare against Netflix.

Not only does the stock carry a negative valuation multiple (because of its negative earnings), but markets are not buying the EPS projection set by analysts today. 94.4% EPS growth in the next twelve months? Markets decided to pass on it, so if you want a turnaround play, you got it along with Burry.

So now that the favorite child has been spotted, how do you know to justify today’s valuation coming into earnings?

Connect the dots

It’s all about growth this year, especially with the new FED view to cut interest rates after its aggressive campaign to hike rates to combat stubborn inflation throughout 2023. If rates decline, each investment dollar that is just sitting in bonds or savings will bring back lower returns, making stocks more attractive.

Not all stocks are created equal, which is why those with potentially high growth are the ones likely to attract more investment dollars in the coming months. So, what is Wall Street expecting out of Netflix in the next twelve months, and more importantly, how are its competitors looking?

While not the most aggressive growth story in the space, Netflix analysts see an EPS expansion of 32.8% this year. However, these same analysts see a price target of only $485.7 a share, which is where the stock trades today. They may be signaling that today’s prices have already discounted tomorrow’s growth, but remember, “It must be expensive for a reason.”

The reason? For starters, Disney is only set to grow its EPS by 23.4% in the next twelve months, below the spotlight, Netflix. More specifically, insider bullishness cannot be ignored at Netflix.

Within their latest quarterly earnings report, Netflix management pointed to some favorable trends in the company’s free cash flow (operating cash flow minus capital expenditures), which is set to reach a record level this year. They have also upped their share buyback program to a staggering $10 billion.

Buying back nearly 5.0% of the company’s market capitalization is no small feat. It directly translates the optimism in the company’s management, signaling that the stock is not only cheap today but could make a move higher soon.

Source MarketBeat