What Netflix Taught Investors About Quality

What Netflix Taught Investors About Quality

Not all FAANGM stocks are created equal—a truth made apparent by Netflix’s recent stock price plunge following its earnings report.

We all know the “FANG” stocks. They dominate the Nasdaq 100 index and are sometimes isolated into an index of their own. And known for high growth and as stay-at-home beneficiaries, the stock prices have performed well above market averages in recent years. However, being linked in an index or by a shared positioning in the mind of investors doesn’t mean that each stock holds the same footing in terms of fundamental quality. We saw this play out in real time on January 20th.

The popularity of indexed investing has indiscriminately pushed capital into all index components (typically) based on their market capitalization.  The large get larger to the point where just six stocks represented a quarter of the S&P 500 value.  The epitome of indexing would be to purchase the FANG stocks as a group (either cap weighted or equal weighted).  The fewer index components, the more concentrated the risk.

Now let’s drill down even further and look at just two components of the FANG constituents starting near the Nasdaq high in early November—Microsoft and Netflix.  Granted, Microsoft carried a market cap nearly 9 times that of Netflix but they are both popular components of the FANG group, and as such, are often grouped together. 

Why is this indiscriminate coupling dangerous? While any high growth stock can enjoy smooth sailing when all is well (when sales and earnings meet expectations), vulnerability to disappointments tends to revolve around quality.

So let’s look at Microsoft versus Netflix. The table below highlights some key quality and valuation comparisons.

The importance of quality measurements when investing in high growth companies cannot be understated.  Netflix recently reported revenues and earnings in line or better than expectations, but subscriber growth declined 2.6% year-over-year.  It was not a loss of subscribers – just a slower growth rate. Microsoft earnings and revenues also beat expectations although revenue growth in cloud was a bit disappointing. Both companies had reasonably good reports with only minor disappointments.

One Year Comparative Growth: Microsoft vs. Netflix

One-year comparative growth between Microsoft and Netflix, from January 25, 2021 through January 25, 2022

Since their November highs, Microsoft stock is down 12.6% and Netflix is down 45%.  Quality matters – especially in growth stocks.

The information and opinions in this report have been prepared by the investment staff of Advanced Asset Management Advisors (AAMA). This report is based upon information available to the public. The information herein is believed to be reliable and has been obtained from sources believed to be reliable, but AAMA makes no representation as to the accuracy or completeness of such information. Opinions, estimates and projections in this report constitute AAMA’s judgment and are subject to change without notice. This report is provided for informational purposes only. It is not to be construed as a recommendation to buy or sell or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy in any jurisdiction in which such an offer or solicitation would violate applicable laws or regulations.

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