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Netflix vs. Disney: Has Netflix gone too far too fast?

Currently the overall stock market is trading at a premium, no doubt about it. Is it a bubble? That is yet to be seen. One thing is certain, however, some stocks have nose-bleed valuations. One such stock is Netflix (NFLX,) which is currently trading at a valuation of over 200 times earnings.

To many this valuation is reminiscent of the late 1990’s. However, investors will point out that numerous companies in that time frame did not turn any profit, whereas Netflix does. Yet, even wildly profitable companies in the late 90’s, such as Microsoft (MSFT) have only recently reached their former highs. So, has the price of Netflix gone too far too fast?

To answer that, let’s compare Netflix to one of its competitors. At present Netflix trades at nearly 200 times earnings and has a market cap of around $160 billion. Whereas Disney (DIS) trades at a PE of 16 and has a market cap of around $150 billion. Clearly the market is putting a premium on Netflix.

Netflix and Disney both compete in the media production business. Disney will be soon launching its own subscription service which will compete directly with Netflix. Both companies will be seeking the attention of cord-cutters going forward.

Media companies are fighting for your time. Will there be a clear winner?

Netflix is spending $8 billion in 2018 to produce content. This makes Netflix one of the largest spenders on media production in the world. While Netflix has produced some hit series, most of the content produced by Netflix is of “B” quality at best.

In addition to the Disney productions, Disney owns Pixar, the Star Wars franchise, and most of the Marvel superheroes. This is in addition to ESPN, ABC, and A&E. If Disney succeeds with its attempt to purchase FOX, it will acquire all the FOX content in addition to 60% of HULU. It is hard to argue that Netflix can match the content quality of Disney.

Disney also has a diversified business. This is something that Netflix cannot match. In fact, media production is roughly only half of Disney’s business. Disney generates a large chunk of its revenue from its theme parks and consumer products. This is the magic of having strong characters.

But how much money do the two companies make?

In 2017, Netflix reported an annual profit of $558.9 million. However, the company is projecting to make that much in just the first half of 2018. That is an incredible growth rate. Of course, they did this with a negative cash flow of nearly $2 billion. Analysts expect Netflix to grow earnings over the next five years at a rate of 37%. But how does this compare to Disney?

In contrast, Disney generated nearly $10 billion in net income in 2017. In doing so, they created nearly $9 billion in free cash flow. However, the growth rate of Disney is only expected to be around 10% for the next five years.

There is no doubt that both companies will flourish in today’s cord-cutting world. The extreme optimism on Netflix stock should be a warning to investors. Even if Netflix manages to double profits for the next 4 years they will just be catching up to where Disney is today. Perhaps they will find a way to maintain the incredible growth rate, but the outcome is far from certain.