Is Netflix, Inc. (NASDAQ:NFLX) Creating Value For Shareholders?
Today we'll evaluate Netflix, Inc. (NASDAQ:NFLX) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Netflix:
0.096 = US$2.6b ÷ (US$34b - US$6.9b) (Based on the trailing twelve months to December 2019.)
So, Netflix has an ROCE of 9.6%.
Check out our latest analysis for Netflix
Is Netflix's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Netflix's ROCE appears to be around the 9.7% average of the Entertainment industry. Setting aside the industry comparison for now, Netflix's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Our data shows that Netflix currently has an ROCE of 9.6%, compared to its ROCE of 4.2% 3 years ago. This makes us wonder if the company is improving. You can see in the image below how Netflix's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Netflix's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Netflix has current liabilities of US$6.9b and total assets of US$34b. As a result, its current liabilities are equal to approximately 20% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Netflix's ROCE
That said, Netflix's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than Netflix. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
