If we go back 15 years, it would sound odd to hear these two mentioned as competitors for delivering movies and TV shows. Amazon (NASDAQ: AMZN) started out selling books online, while Netflix (NASDAQ: NFLX) simply mailed DVDs to subscribers.
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But both are prime examples of successful evolution overtime. That agility has handsomely rewarded shareholders in both companies over the past decade.
Image source: Getty Images.
Which is the better buy today? That's an impossible question to answer with 100% certainty, but there are ways to get a better idea of what we're buying with each. Let's consider the companies through three crucial lenses to see how the two stack up.
Sustainable competitive advantages
Berkshire Hathaway vice chairman and investing sage Charlie Munger recently gave an interviewwhere the topic turned to investing abroad. The journalist tried to ask what investors should look for in a potential investment.
But before he could even finish, Munger essentially cut him off: "Durable competitive advantages," he said. Whether we use the words "sustainable," "durable," or simply call it a "moat," the primacy of Munger's response speaks volumes.
At its core, a moat is what makes a company special. It keeps investors coming back for more, week after week, while holding the competition at bay for decades.
Netflix has several moats. The brand is well known. It owns some of the most popular original content on the Internet in House of Cards, Orange is the New Black, and others. And its subscription roster is nearing 100 millionworldwide.
But I recently arguedthat the real moat is a sneaky one: low switching costs. By that, I mean that a subscription can cost as little as $8 per month and is usually paid for via credit card. That's a small enough sum that once someone signs up, they would need a pretty good reason to take the time to cancel their subscription. By and large, once someone is in the Netflix ecosystem, they're there to stay.
Amazon benefits from two key moats: scale, and the network effect. On the "scale" front, Amazon has 102 fulfillment centers in the United States and 393 total. The locations and ubiquity of these centers are the key reason Amazon is able to get packages to your doorstep quicker than anyone else.
The way things are now, there won't be others offering such a service anytime soon. That's because it takes billions of dollars and years to build out such a network. It would be prohibitively expensive for the competition to do so, especially when it would still have to deal with Amazon at the end of the day.
Next, the network effect. Amazon Prime rosters have swollen to an estimated 66 millionhouseholds. Third-party vendors see such numbers and realize that it would be easier to get their products in front of new eyes by listing them on Amazon's platform and using its fulfillment services. That migration of products incentivizes still more customers to go to the site -- and the cycle continues anew.
While Netflix's moat is deceptively wide, the network effect taking place at Amazon right now is too powerful to ignore.
Winner = Amazon
Amazon and Netflix are both well-known for their penchant to plow sales back into the company, sacrificing short-term gain for long-term dominance. So far, that's worked out pretty well.
Still, it's important for any company to keep a healthy cash stash on hand. That's because difficult economic times visit every organization at one point or another. Companies with cash on hand have options: Buy back shares on the cheap, acquire the competition, or simply outspend rivals to grab market share.
Debt-heavy companies are in the opposite boat, forced to cut all future initiatives in an effort to simply live another day. Here's how these two stack up in terms of financial fortitude, remembering that Amazon is valued at seven-and-a-half times the size of Netflix.
Data sources: SEC filings, Yahoo! Finance.
Here we have a very clear winner. Because Netflix is so focused on international expansion -- and is paying a king's ransom for original content -- Amazon is on much firmer financial ground.
Winner = Amazon
Finally, we have valuation. While we don't have a one-size-fits-all metric to compare any two companies, we can use multiple data points to make an informed analysis.
Data sources: SEC filings, Yahoo! Finance. P/E calculated using non-GAAP EPS.
It's not often that we find a company trading for a higher multiple than Amazon, but in Netflix, we've found one.
However, there are a couple of factors making this a pretty even match. First, Amazon's free cash flow is inflated by capital leases, which means its free cash flow multiple -- depending upon how you look at it -- is far higher than 44. Secondly, after factoring in growth (PEG ratio), Netflix appears to be trading at a 50% discount to Amazon.
Putting all of this together, and remembering that Netflix is free-cash-flow negative, I believe we have a draw, here.
Winner = Tie
Our winner is...
There you have it: Both stocks are extremely expensive, but Amazon is a better bet. The company not only has a stronger balance sheet, but a wider moat protecting its core businesses.
That helps explain why -- even though I own shares of both companies -- Amazon occupies 20% of my real-life holdings, while Netflix is a much smaller 2%. While there's never a great time to "back up the truck," long-term investors should give the e-commerce giant a long look before moving on to other stocks.
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