One of the most overvalued stocks on the market, Netflix (NFLX), issued third-quarter results Wednesday that sent shares tumbling. The company’s quarterly report wasn’t bad; the firm’s top line was in-line with expectations, and the firm’s bottom line beat consensus. However, the market wanted more. Market prognosticators were looking for the company in the third quarter to add ~3.6 million subscribers, which matched the company’s guidance. Netflix added only 3.01 million–not a bad mark, but disappointing relative to expectations. Remember: value is based on future projections of free cash flow, and what was embedded in Netflix’s stock price before the report needs now to be adjusted downward; hence the decline in shares.
Even after the fall in price, however, you won’t find us going anywhere near the company’s equity. Netflix’s shares are still pricey. Just because a stock falls in price, the move downward doesn’t always make it a bargain. The stock is falling for a specific reason (lower subscriber growth trajectory), and only after this lowered subscriber growth trajectory has been embedded into the valuation can a value-versus-price assessment be performed. When a stock’s price falls, it is almost a certainty that the valuation of the company needs to be adjusted lower as well. The market is not completely irrational.
If we were Netflix shareholders, the chart of its net income and free cash flow would have us running for the exits (it looks like many are). Usually when free cash flow is trailing net income by such a wide margin, something fishy is going on—with respect to working capital. This chart tells us more about Netflix’s financial health and outlook than anything else.
Image Source: Netflix
A few hours before the Netflix disappointment, Walmart (WMT) updated guidance at the end of its investor day. The company lowered its net sales growth expectations for fiscal year 2016 to a range of 2%-4%, down from 3%-4% range updated in February. In the case of a company as large as Walmart, even a point or two of growth on the top line really moves the needle. The sales environment remains tough as dollar store operators continue to gain share.
Walmart updated its capital spending plans, too. The firm now plans to spend $1.2-$1.5 billion in fiscal year 2016 on e-commerce and digital initiatives, up 20%-50% from this year’s approximate mark of $1 billion. Though we like the areas of investment, it appears that management thinks it will take some time for such investments to pay off, given the downward revision in sales expansion. The biggest operating losses for its e-commerce operations are expected to come over the next 18-24 months. Total capital spending for fiscal year 2016 is to be slightly lower than that of fiscal year 2015, easing free cash flow pressure to a degree.
Image Source: Walmart
Walmart’s dividend is healthy, but we don’t like the trajectory of its sales trends. We generally prefer ideas in both the Best Ideas portfolio and Dividend Growth portfolio over the retailing giant.