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Better Buy: Netflix vs. Google

Jeremy Bowman, The Motley Fool

They're the the last two letters in the famed FANG group of stocks, and two of the best-known tech companies out there. 

Netflix (NASDAQ: NFLX) and Google-parent Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) both have plenty of attractive features for investors. The two are leaders of their respective industries. Netflix dominates video streaming, while Google has long been the titan of online search.

A scale holding two sets of coins.

Image source: Getty.

As stocks, both have outperformed the S&P 500 in recent years, but Netflix has been the clear winner. The company has consistently bucked the odds, transitioned into a Hollywood powerhouse with a formidable original content division, and expanded into an international business.

NFLX Chart

NFLX data by YCharts

As you can see from the chart above, Netflix has delivered phenomenal returns over the last five years. However, the stock remains risky. Its pullback over the last year at one point shaved nearly 50% off the stock's price. Alphabet, on the other hand, has consistently outperformed the S&P 500 thanks to the reliable growth of its search business, while the company's "other bets" -- like Waymo -- offer chances to develop another blockbuster business.

Let's take a closer look at what each stock has to offer today to determine which is the better buy going forward. 

Streaming into the future

Netflix has rewritten the rules of the entertainment industry over the last decade. It's taken what it has learned from that to find new opportunity and keep expanding. The company just reported record quarterly subscriber additions in its first quarter of 2019, and its second-quarter projection is on pace for another record year of subscriber additions. That's a trend it has maintained every year since it split its streaming service from its DVD-by-mail offering in 2011.

Though Netflix has come to define streaming in the U.S. and is the clear market leader with almost 62 million subscribers, its biggest opportunity may be international, where it now has nearly 88 million subscribers. International subscriber growth is ramping up as the company pours money into foreign, local-language content. It added nearly 8 million international members last quarter.

Despite the stock's track record, there are legitimate concerns for investors to consider.

First, Netflix will face a new wave of competition, with Apple and Disney both set to launch streaming services later this year and AT&T likely to join them with WarnerMedia. Management has played down those threats, arguing that the market for entertainment is so large that it's hard for one competitor to make a significant difference. Still, new entrants could drive up the price for content it needs to attract subscribers, and also compete for viewer dollars. 

Netflix shares also remain expensively priced (trading at a triple-digit P/E ratio), and the company is still burning cash. It's on track to report -$3.5 billion in free cash flow (FCF) this year. Management said that FCF should improve significantly starting next year as it moves toward being cash profitable, but that risk has been a huge concern for value investors like NYU Professor Aswaith Damodoran, who last year valued Netflix shares at just $172, more than 50% below where they stand today. 

Until its subscriber growth hits an inflection point, Netflix seems worthy of an ambitious valuation, as profits should eventually catch up. But whether the company deserves the lofty valuation it has today is a fair question.

A search gold mine and more

Alphabet's search engine is one of the most valuable businesses in the world. Google properties (including Google.com, Gmail, Google Maps, Google Play, and YouTube) brought in $96.3 billion of high-margin revenue last year. Alphabet had an operating margin of 19.2%, though that was likely significantly higher for its core Google business without the costs of its Other Bets and its $5 billion fine from the European Commission.

Alphabet's revenue, which grew 23.4% last year to $136.8 billion, is primarily being driven by paid ad clicks. Those surged 62% last year due to increases in YouTube engagement ads and mobile search queries, improvements in ad formats and delivery, and global expansion of its products, advertisers, and user base. However, that growth was partially offset by declining cost-per-click rates, caused by a shift towards lower-priced YouTube engagement ads, mobile clicks (usually lower-priced than desktop ones), and lower-priced clicks in developing countries.

Despite steadily falling cost-per-click rates, Google's paid clicks have consistently risen, and that revenue driver seems likely to persist for the foreseeable future due to the strength of Google search and YouTube. However, Alphabet also faces new competition, notably from Amazon's fast-growing advertising business, which has the power to take valuable product-search revenue from Alphabet. Still, when it comes to direct search, Google has no meaningful competitor.

Elsewhere, Waymo presents a huge potential upside, as some analysts have valued the autonomous-vehicle division at as much as $150 billion. Waymo launched its Waymo One AV ridesharing service in Phoenix last year, and the service is expected to eventually spread to other cities. Further down the road, its early stage Other Bets offer similar potential.

Considering that combination of businesses, Alphabet's valuation looks very reasonable at a P/E of 28.4.

What's the better bet? 

The choice between Netflix and Alphabet will likely come down to your investing style. Netflix has a triple-digit P/E ratio of 132.2 and is clearly the riskier of the two stocks, so it's likely to appeal to more growth-oriented, risk-tolerant investors. Though Alphabet isn't cheap at a P/E of 28.4, its steady business model built around recurring revenue makes it a reliable stock for delivering steady profit growth.

There's one other important difference investors should consider: Alphabet has already reached a market cap of more than $800 billion, meaning it will be difficult for the stock price to double in value again in the next few years as the law of large numbers starts to apply. Though Netflix is certainly not a small company (its market cap tops $150 billion), it's much more realistic for its stock to double again, or even triple over time. This is especially true if its profits begin to ramp up or it expands into new business segments like movie theaters or sports.

Personally, I would choose Netflix because of its growth potential. But Alphabet may deserve a spot in your portfolio as well because of its combination of competitive advantages, steady profit growth, and reasonable valuation.

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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 Amazon, Netflix, and Walt Disney. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, 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.