I don’t write consistently, so when I logged in this morning, I ran across a post on NFLX I made, but didn’t publish last year. And I instantly knew it was an awful post with misguided logic.
Since I wrote an article on Netflix (NFLX) titled “Thoughts On NFLX”, I’ve learned more about cash flows. While I am no accounting expert, the key concept is that Net Income is a smoothed out, GAAP approved, look at earnings. It incorporates depreciation over time instead of instantly, and several other factors. However, if you look at the cash flow statement that I always neglected, you can see the Net cash provided by continuing operating activities also called Cash generated by operating activities, or simply Cash from operations.
Cash from operations shows how much cash the company made from running their business over a specific time frame. As I understand it, unlike net income, this number is calculated the same way for every company. There are not a lot of judgement calls other than what the line items are. Cash flows are hard to fake.
So let’s turn to NFLX’s 2022 10k. The cash flow statement for the year is on page 40. Net cash provided by operating activities was $2.02B for 2022. If you look at all the adjustments to net income, you’ll see Stock-based compensation expense (SBC). This is an approximation of how much employees were paid in stock. For NFLX, this charge was $575M in 2022. Also, if you look at Cash flows from investing activities: you’ll see $407M was spent on property plant and equipment (PPE). Using these three key numbers, we can estimate what an owner of NFLX could have paid themselves in 2022. $2.02B – .575B – .407B = $1.038B.
This sounds authoritative, but it is a very broad generalization. Obviously the content Netflix produced this year has residual value going forward. In 2032, someone out there would pay a little bit of money to watch season 2 of the Witcher. Probably not a lot of money, but some. It should also be clear that if Netflix stopped producing content at all, its user base would quickly start shrinking. Netflix has to produce content to sustain its subscriptions.
Some amount of this year’s spending is benefiting the future. Netflix is trying to push into new markets and attract new users with new shows. Perhaps a day will come when Netflix can lower content spending and see a large increase in cash flow. I’m not willing to make that assumption. Competition is fierce.
But we do have cash flow today! Cash flow that I think is sustainable. As an owner, you could have distributed $1.038B to yourself this year. As I like Netflix and risk free rates are low, let’s say I’m willing to pay a premium of 20x owner’s earnings. That means if Netflix doesn’t grow, I’ll get all my money back in 20 years, or 5% a year. That’s better than a T-Bill, but not much.
That’s $20.76B for Netflix. While I could calculate the share price, a quick glance on Google Finance shows Netflix’s market cap today is $165B. That’s 165x owner’s earnings in 2022. Which is outrageous, IMO. However, the P/E ratio listed on Google Finance is a reasonable by comparison 40x. Wait, What?
My awful blog post from last year? That was before I learned to also look at a company’s cash flow. And Netflix happens to be one of those companies where cash flow and net income are very different. The company claims it earned $4.4B in 2022. However, it only produced $2B in cash. As I’m not an accounting expert, I’m going with the cash flow number.
This new accounting knowledge has had very large implications in my investing. For instance, TSLA’s latest earnings report (Q4 2022), shows a rise in net income, but a drop in cash flows. These days, I’m trusting the cash flow statement.
This week, I ran across a far better explanation than I’m giving, from a far smarter fellow. So if you are a little lost in how this works, I totally understand. I’m no expert, so I’ll let Jeff Bezos explain it.