Amazon.com (AMZN), everyone's favorite do-everything retailer, has a market cap near $200 billion and trades at a forward price/earnings multiple of 165x -- making it about 10x more expensive than the average large-cap stock.
Meanwhile, Netflix (NFLX), which has redefined the television viewing experience, weighs in at $34 billion market cap and trades at a 158x multiple of next year's earnings.
On the surface, those valuations seem absurdly high -- especially when you compare them to a company like Apple, which generates about $60 billion in annual operating cash flows, and trades at a measly 13 times 2016 earnings.
Comparatively, buying shares of Apple is like shopping from the bargain bin, while Amazon and Netflix shares are priced like Jackson Pollock originals.
So what gives?
Taking a look at Amazon.com first, despite the fact that the online retailer actually lost money in two of the last three years, it is the unequivocal leader in the e-commerce industry and continues to snag market share from traditional retailers. It essentially has unlimited online shelf space and has, almost by accident, become the de facto destination for product reviews. No other retailer can boast that consumer product reviews actually help drive revenues to the extent that they do at Amazon.
Although the company generated $89 billion in sales in 2014 and has grown revenues by double digits annually for well over a decade, the market opportunity that lies ahead is even more exciting.
According to the U.S. Department of Commerce, only 6.5% of total U.S. retail sales were estimated to be e-commerce transactions. Couple that with the latest data from Internet World Stats that indicates just four in 10 people globally have access to the Internet, compared to an 88% penetration rate in the United States. That means Amazon is sitting at the intersection of two of the most compelling growth stories imaginable. That's an opportunity that's hard to ignore, even at lofty valuations.
The future expansion of online retail (both domestically and abroad) is impressive enough, but factor in its other operating units like Prime, original video content, and its sensational, pioneering cloud-computing services, and it becomes much easier to make the bull case. (My business runs on Amazon Web Services, and there's really no competitor within miles of its pricing, features and reliability.)
The story behind Netflix's valuation isn't as easy to make, but it's there if you squint. In mid-April, the company reported net income of $24 million, below expectations and down from the $53 million in reported income a year ago. Yet shares have responded by climbing 17% since the earnings announcement because the number that matters most to investors -- subscriber growth -- was super-impressive.
Netflix added 4.9 million net subscribers during the previous quarter, bringing its total streaming subscriber base to 62.3 million. Let's put that into perspective for a moment. Comcast and Time Warner Cable are the two largest cable companies in the country, and they combined to account for only 33.4 million subscribers at the end of last quarter!
Many analysts, including Richard Greenfield with BTIG, believe that the company will surpass 100 million global subscribers in the next two years, and 200 million by 2025. That seems almost ridiculous, but when you pay nearly 100 times earnings for a company, this is what you get: uncharted territory.
Not only is Netflix growing its user base at a phenomenal rate, but it's deepening those relationships with a concentrated focus on original programming. According to comScore, consumers spent 24% more time on Netflix last quarter than they did during the same time period a year ago. Additionally, Netflix shares the international expansion story with Amazon, as the streaming service is now expected to be in 200 countries by 2017.
The case against the company is that it continues to burn through cash, and that expenses will continue to accelerate as it adds more original shows and third-party-content costs rise. Surely future monthly price increases are a foregone conclusion, so that sub-4% monthly churn rate will certainly be tested.
But, for all the fuss about its rising content costs, Netflix spends about 7 cents per hour viewed on content, with Morgan Stanley (MS) estimating that traditional broadcast networks average about 13 cents per hour of content viewed. So, it is spending the money wisely, and will benefit from the network effect of growth.
Don't expect Amazon or Netflix to show up on value investor lists anytime soon, but both companies have very unique opportunities that go well beyond next year's earnings expectations. Outside of some new game-changing product -- and I don't mean you, Apple Watch -- even Apple has clearly defined growth limitations. Yet, somehow, it still feels very much like we are still early in the story for both NFLX and AMZN.
The global expansion of high-speed internet access, combined with a hard push from both companies to expand internationally, is a compelling story. It's certainly compelling enough for investors to put aside near-term valuations and pony up for these trailblazers.
Shares of NFLX are up 62.9% this year, while AMZN has risen nearly 36%, with neither showing signs of slowing down. I am not ready to recommend them at this moment, but would do so on any major 10%-plus pullback.
-- Jon D. Markman
-- Sign up for a free trial to Strategic Advantage to see ideas like this every day.