Netflix (NASDAQ:NFLX) and Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) certainly have a way of keeping our attention. American Netflix subscribers spend an average of an hour and 40 minutes per day watching the streaming service. YouTube’s 1.8 billion monthly active users stream an hour of video per day on their mobile devices alone.
Alphabet has built a massive revenue stream from advertising on its properties, including YouTube, Google Search, and Gmail. Meanwhile, Netflix’s ad-free model relies on a growing subscriber base and consistently raising prices.
Investors interested in the two internet giants’ stocks may have a tough time deciding. Let’s take a closer look at the current growth of the two companies and their stock valuations to help make that decision.
Image source: Netflix.
The leaders of two megatrends
Netflix and Alphabet are at the forefront of two related megatrends: the shift to streaming video from traditional linear television (i.e., cord-cutting) and the natural shift of advertising budgets to follow eyeballs from television and other traditional media to digital media.
Netflix has nearly 60 million U.S. subscribers and another 80 million international subscribers to its streaming video service. Revenue grew 35% in 2018, faster than the 26% growth in paid memberships thanks to strategic price increases in certain markets.
After increasing prices for U.S. members at the start of 2019, Netflix could expect to see another year of 20%-plus growth in U.S. revenue. That growth might slow next decade as more competition enters the market and price increases become harder to sustain.
Netflix’s strong international membership growth ought to continue, however, as Netflix’s content library becomes increasingly global. International revenue grew more than 50% in 2018, and there’s no sign of a slowdown in membership growth. That ought to ensure Netflix can maintain a high overall revenue growth rate for the foreseeable future, even as growth slows in its domestic market.
Google, meanwhile, is is still growing its core advertising business at a steady clip. Ad revenue climbed 22% in 2018, faster than the overall digital advertising market. YouTube is a big part of that growth, as Google remains a dominant force in internet search. Google’s cloud computing and hardware businesses are growing slightly faster than its advertising business, but at lower margins. Revenue from Alphabet’s other bets is irregular and currently not meaningful to the company.
Revenue growth will continue to slow slightly at Alphabet because of the law of large numbers. But if one of its other-bets projects, such as Verily or Waymo, starts bringing in meaningful revenue, Alphabet could quickly reaccelerate its revenue growth.
Image source: Google.
Margins heading in opposite directions
Despite Netflix’s heavy investments in content and marketing, the company is showing significant operating leverage as it scales its subscriber base. Netflix amortized $7.5 billion of content in 2018, but it managed to produce an operating margin of 10%. It expects both of those numbers to climb in 2019, the latter to 13%.
Netflix’s content and marketing spend growth is starting to subside. Management expects its cash burn to start moving back toward positive territory after remaining relatively flat for this year. That indicates it’s starting to show revenue growth well in excess of the growth in its cost of sales and its operating expenses.
Alphabet is trending in the opposite direction. While it has a relatively high operating margin — 27% in 2018 — that number is trending downward. Growth is coming more from lower-margin products than its core Google search advertising business, including YouTube, cloud computing, and hardware sales. Alphabet is also paying higher traffic acquisition costs as more internet browsing shifts to mobile, where its own Chrome browser is less dominant.
So while Alphabet’s revenue growth is keeping up with Netflix’s for the most part, its operating margin is heading in the opposite direction.
A look at valuation
Data source: Yahoo! Finance.
Netflix’s relatively high levels of debt — which it uses to fund its content investments — make it especially expensive on an EV/EBITDA basis. It’s less expensive on a forward P/E basis, but still more than twice the valuation of Alphabet.
Netflix is poised to grow earnings at a rate substantially faster than Alphabet over the next five years, thanks to its expanding operating margin. That said, that growth carries a lot more risk because of the high level of debt, the uncertain impact of increased competition launching in the near future, and the extent to which it can manage continued price increases.
Alphabet is priced as a relative value and still holds the significant upside of its other-bets projects. As such, Alphabet is a better buy for most investors right now.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Adam Levy owns shares of Alphabet (C shares). The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Netflix. The Motley Fool has a disclosure policy.