After several weeks of gains, stocks took a breather the first two days of this week. While there were some notable gains on better-than-expected earnings, including IBM# yesterday, for the most part merely beating estimates by a penny or two has been setting stocks up for a pause. The old adage “buy on the rumor, sell on the news” applies. Bank stocks in particular, which have had such a big run through much of 2021, have retreated after reporting robust results. A pause in the rise in interest rates may have been a contributing factor.
For many companies most impacted economically by Covid-19, a return to normal, which may still take several more months, has largely been discounted. For those recovery names, investors have to see another leg forward to renew their enthusiasm.
Last night, Netflix reported solid results in terms of sales and earnings. But new customer sign ups fell short of forecasts and the stock is down 8% in pre-market trading. Is Netflix maturing? Or is it simply a case of the surge in new customers during last year’s first half during times of quarantine simply pulling forward new customers that will even out soon? Maybe it was a function of lack of new programming impacted by the effects of Covid-19. Whatever explanation proves accurate, I think some general conclusions can be drawn. In the U.S. and throughout much of the developed world, virtually everyone who can afford Netflix either is a subscriber or has chosen not to be. In terms of customers, this is a maturing market. Newer overseas markets have another year or two (or three) to catch up, but they aren’t that far behind. Obviously, the success of Netflix has attracted lots of competition. Dozens of major entertainment companies now offer streaming services. While none has the range of products to match Netflix yet, collectively they do. TV hounds can order any service for a trial or short period and cancel either after binge watching a series or if not satisfied.
Netflix’s stock reached a peak in January in the wake of the 2020 Covid-driven surge. While it is still growing, its growth rates are likely to decline over time. That means its P/E will decline as well. Netflix’s stock this morning trades at under 40x 2022 estimated earnings. That’s a big number for most companies but it is the lowest P/E ever for Netflix.
The point of all this isn’t to make an investment case for or against Netflix. Rather, it is a real time reminder that the best companies cannot resemble a moonshot forever. This year, with all the new SPACs and IPOs, investors are offered a bunch of moonshots to choose from. Each would like to be the next Netflix. More than likely, the vast majority will never get to profitability. Great ideas are not the same as great companies. Any great idea that becomes reality will attract competition just as Netflix is doing today. But three dozen companies proposing to make electric cars of the future are not all going to be the next Tesla. Designing an electric van and getting a company like UPS to agree to buy some, if you can produce them in quantity and quality, is great if you can deliver. But the UPSs of this world won’t buy anything that doesn’t match contract standards. The devil is in the details.
Let me put a wrapper on all this.
1. Netflix now sells at <40x 2022 earnings. Facebook# and Alphabet# now sell at <30 times forecasts. So does Apple#. Apple is unlikely to grow in excess of 10% annually anymore.
2. Great companies reinvent themselves constantly. Netflix morphed by sending DVDs in the mail to a streaming service for older movies, to the best producer of original content. It isn’t done.
3. Great companies are hard to create. Of the companies born in the 1990s that were the stars of the first Internet bubble, only Amazon became a superstar.
4. Great ideas and great products don’t make great companies. Great ideas and great products get copied. Pioneers without superior management fail. By fail I mean they disappear rather quickly. If you don’t believe me, look it up on Netscape or contact me via AOL.
5. Too much money chasing too few good ideas creates bubbles. These bubbles don’t last long. GameStop is now less than a third of its peak. I doubt it has bottomed yet. Many of January’s SPAC offerings are already underwater. Most will be before 2021 ends.
6. Growth is great. But decelerating growth sets up a battle between declining P/Es and earnings that are rising at an ever slower pace. Humans rarely live to be 100. The same is true for corporations. The world changes. It is hard to perpetually reinvent oneself, but it is what corporations have to do to survive. Even staples like Coca Cola have to change and adapt.
7. That’s why, as investors, you can’t afford to fall in love with everything you own. While taxes may lock you in, staying with an old favorite in decline will cost you more money in the end.
8. In 1980, the top 10 of the Fortune 500 were (in order) Exxon, General Motors, Mobil, Ford, Texaco, Gulf Oil, IBM, GE, and Amoco. Four have been swallowed, General Motors went bankrupt before recovering, and GE has been a well documented mess. If I moved forward to 2000, the most notable addition would have been Walmart. The only tech name was still IBM. If I moved forward to 2020, the only name on all three lists is ExxonMobil. You get the message. Times change and investors need to change as well. But pioneers and dreamers rarely rise to the top. That’s what makes investing challenging.
Today, Iggy Pop is 74. Queen Elizabeth II is 95.
James M. Meyer, CFA 610-260-2220