Netflix, Inc. (NASDAQ: NFLX) and Alphabet Inc.'s (NASDAQ: GOOGL) (NASDAQ: GOOG) Google both operate in the online arena and dominate in their core businesses -- Netflix in the realm of video streaming, and Google in the area of internet search. Each has also been a stellar performer and rewarded shareholders handsomely over the last several years.
Google and Netflix both have their roots in Silicon Valley, were founded in the late 1990s, and have gone on to become household names.
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Still, these companies operate in very different spaces. Which is the better buy now? Or are they both great opportunities?
Netflix: Netflix became the worldwide leader in online streaming by deploying its video on demand in the U.S., perfecting it, and then expanding its service to 190 countries around the world in early 2016. That said, the company has barely scratched the surface in many of those markets and could foreseeably achieve penetration rates similar to those in its U.S. market. With 51 million subscribers out of 126 million U.S. households, this equates to a 40% penetration rate. Even excluding the few countries where Netflix streaming isn't available (China, Crimea, North Korea, and Syria), its subscriber base could grow to as many as 240 million worldwide.
The company's cash flow will remain negative for some time while Netflix builds out its library of original content. Thereafter, decreasing incremental costs will kick in and a greater portion of revenue from each subscriber will become mostly profit. Netflix has also begun the process of licensing merchandise from its popular shows, potentially creating a billion-dollar opportunity in the process.
Netflix's growth has been fueled by a virtuous cycle -- more and better content leads to more subscribers, and revenue from its growing subscriber base funds additional content. With its worldwide expansion well under way, this should continue for some time.
In its most recent quarter, Netflix's revenue grew to $2.6 billion, an increase of 35% over the prior-year quarter, and posted net income of $178 million, a fivefold increase year over year.
Alphabet: To understand how dominant Alphabet's Google is, consider that Google has become a verb. Advertising revenue from Google search and YouTube account for the majority of the company's sales, but Alphabet is investing heavily in a number of areas with an eye toward future growth.
Alphabet is also one of the leaders in the emerging field of artificial intelligence (AI), resulting in gains in the areas of language processing, translation, and image recognition, among others. Each of these helps to improve Google's core search and provide tools for users of the company's Android operating system for smartphones. Alphabet has developed one of the leading self-driving car technologies with its Waymo division, and recently released its AI-based Home speaker powered by Google Assistant. At some point, Google's advertising revenue will top out, and Alphabet is betting on these initiatives to drive future results. To date, however, they have yet to produce quantifiable revenue.
In Alphabet's most recent quarter, the company produced revenue of $24.75 billion, an increase of 22% over the prior-year quarter, while net income grew to $5.4 billion, an increase of 29% year over year.
Both companies dominate in their core markets. It's still too early to determine how the success of non-core businesses will play out, and recent financial results are both stellar, so thus far, this is too close to call.
Valuation and stock performance
Over the last year, both stocks have beat the broader market. Alphabet's stock has returned 29%, while Netflix shares have risen an incredible 51%.
If you think investors have serious expectations baked into Netflix's stock price as a result, you'd be right. Based on its earnings over the last four quarters, Netflix currently trades at a nosebleed 190 times trailing earnings, while Alphabet has an earnings multiple of 31, making it a much better value. Looking to the future and the results aren't much different. Netflix's forward multiple is 142, compared to Alphabet's forward valuation of 27.
Netflix shares have produced greater returns, while Alphabet shares are a better value, leading to a tie.
It would be very difficult, if not impossible, to call an outright winner in this competition.
Netflix is much earlier in its expansion story than Alphabet and will likely still see years of subscriber gains across the globe. Alphabet's growth will be slower, but should still be impressive for a company its size. Artificial intelligence and Alphabet's other initiatives could provide huge upside in the future, but have yet to produce any significant revenue.
Since both Alphabet and Netflix look poised to succeed for years to come, there simply isn't a clear winner. Investors, therefore, may want to consider investing in both stocks.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Danny Vena owns shares of Alphabet (A shares) and Netflix, and has the following options: long January 2018 $640 calls on Alphabet (C shares) and short January 2018 $650 calls on 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.