Why Netflix Wouldn't Be a Warren Buffett Stock

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Warren Buffett is regarded as the greatest investor in history, and it's clear why. The "Oracle of Omaha" has become one of the richest people in the world through guiding his company, Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), to superior returns over more than 50 years. Unlike other companies, Berkshire essentially functions as a holding company for smaller subsidiaries like Fruit of the Loom, GEICO, and Dairy Queen, and acts as an investment fund, buying billions worth of stakes in publicly traded stocks like Coca-Cola, Wells Fargo, and IBM.

Over the last 50 years, Berkshire stock has delivered an annualized return of 20.8%, more than twice the historical average of the S&P 500 at 9%. Buffett's formula for choosing stocks and buying businesses has clearly been successful, but his philosophy has also led him to overlook some of the biggest winners of the past generation. One such stock is Netflix Inc (NASDAQ: NFLX).

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Shares of the popular streaming service have jumped nearly 23,000% since its 2002 IPO, and the stock has trounced the market more recently as well with a 1,030% return over the last five years. A recent surge just propelled the stock's value of $100 billion for the first time.

Still, Buffett has never owned shares of Netflix and is unlikely to invest in the stock now. Here are a few reasons why.

Where's the value?

Warren Buffett, above all, is a value investor. Trained by famed value investor Benjamin Graham, Buffett believes the best way to invest is to buy stocks when they are trading below their intrinsic value. Though there are differing theories on how to measure intrinsic value, following those guidelines has led Buffett to invest in reasonably priced profit machines like Coca-Cola, IBM, and insurance companies -- investments that spin off dividends every quarter.

Netflix, with its triple-digit P/E ratio and billions in negative free cash flow, is no one's idea of a value stock. The stock's dramatic growth has been driven by its ever-expanding ambition to reshape the way the world consumes video entertainment, first with DVDs by mail, then with video streaming, and now by making its own TV shows and movies and streaming them to customers all over the world.

With more than 125 million global subscribers, Netflix has clearly been successful, but profits have always been thin and competitive threats like Apple, Disney, Amazon, and HBO remain on the horizon. A market pullback or slowing subscriber growth could send the stock plummeting. For an investor like Buffet, the value, and therefore safety, just isn't there with Netflix.

Tech talk

Buffett is famously adverse to tech stocks, preferring instead to put his money in industries like banking, insurance, industrials, retail, consumer staples, and energy. The Berkshire chief generally focuses on businesses with predictable cash flows, that generate repeatable transactions, and have competitive advantages like a strong brand that give them pricing power and therefore outsize profits. When Buffett was beginning his investing career 50 years ago, the tech sector was much smaller than it is today, which may partly explain why he never developed a taste for it.

While some investors believe that Buffett avoids tech stocks because he doesn't understand them, that isn't really true. Instead, the Oracle of Omaha has said that he doesn't know how to value such stocks since he can't predict their businesses or future cash flows. Netflix seems to offer a perfect example of what he means. With its expanding content budget, it's unclear when Netflix will turn free cash flow positive, and subscriber growth has been difficult for the company to project even for just the next quarter. As the company matures, it may become easier to model, but a disruptor like Netflix is by nature a risky venture and is unlikely to have the kind of predictably stable business that, say, Coca-Cola does.

If the billionaire investor scratched the surface of Netflix, he may find a few qualities he likes about the stock. Netflix does have an economic moat, one of the key characteristics Buffett looks for, as it has the leading global brand in video streaming, a massive content library, and an unrivaled subscriber base. Those strengths have also given the company pricing power as subscriber growth actually accelerated in its most recent quarter even though it raised prices.

In the past, Buffett has expressed regret for not investing in tech giants like Alphabet and Amazon, which have gained tremendous market power and delivered huge returns. Considering Netflix's growth and its increasing dominance in streaming, the video streamer may soon join that list of regrets.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Jeremy Bowman owns shares of Apple and Netflix. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Berkshire Hathaway (B shares), Netflix, and Walt Disney. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

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