Motley Fool Hidden Gems Investing - Valuation 101

Episode Date: November 16, 2024

Price matters. But how do you build a case for what the right price is?  Patrick Badolato is a Professor of Accounting at the University of Texas at Austin McCombs School of Business. He joined Ricky Mulvey for a conversation about how to value companies. They also discuss: - How to put P/E ratios in context – and how to look beyond that metric.  - Levers Walmart could pull to double its earnings. - Growth stories for Netflix that go beyond subscriber count.  Companies discussed: NFLX, LULU, TSMC, WMT, NVDA, NFLX, IMAX Host: Ricky Mulvey Guest: Patrick Badolato Producer: Mary Long Engineer: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

You've got to try breakfast at A&W. You've got to try breakfast at A&W. And what better way than with the delicious Pret Organic Coffee? Starting with just one dollar, all day, every day, now until December 31st. You've got to try breakfast at A&W. At participating A&W locations in Ontario. You know, price-to-earnings multiple is like a beginning, one beginning, one very useful reference point to think about what the company is, what they're worth, what the market is valuing at the moment. And so with that lens, it's the starting point to valuation.

Hey, why is? It's the starting point for these kinds of conversations. Why is it? Or what is the market pricing? Why is it that the price-to-earnings ratio would be higher than average? You know, are there fundamental reasons related to the company's performance that will be less than the market average? So it's the starting point where we can start to flesh out those conversations about companies. I'm Mary Long, and that's Patrick Badalotto. He's a professor of accounting at the University of Texas at Austin's McCombs School of Business and a return guest on Motley Fool Money. My colleague, Ricky Mulvey, caught up with Badalotto for a conversation about how we put a price tag on companies.

They also discuss why PE ratios get a bad rap and how to make that metric more useful, the value levers that Walmart could pull to double its earnings, and Netflix's expansion opportunities beyond subscriber growth. Patrick, I know why financial analysts want to spend time building cash flow models and why accountants are able to use this language to communicate valuations. But why should regular retail investors that are, you know, investing a couple hundred bucks in the stock market every month, why should they spend the time valuing the companies that they own? That's a great question, Ricky. I think one of the main reasons just that whether we're doing

it directly or not, you know, when we're making an investment, we are giving an opinion about what we think about the value of the company. And at the most basic level, if we're going long and buying a stock, we're saying that we expect it to go up or go up better than other alternatives. And so that in and of itself is valuation. That's not necessarily all of the specific modeling that happens in the professional world. But still, you're making an investment in stock, you're doing valuation. I want to get into ways, because you have a couple of LinkedIn posts about how this can be simplified. And I ran through it with Netflix, and we'll hopefully get to that a little bit later in the show. But I thought you brought up one idea that seems interesting,

which is, quote, the output or value we expect to get out of something is a function of what we put in on a recurring basis. Valuation fits into this idea. And we often think about it in terms of nutrition, practicing a fine motor skill, exercise, that kind of thing. But let's take that away from the human achievement part. How does valuation fit into that idea? Great. And I actually really try to, you know, in communicating this material to students, always make sure that there is a human element to it. So I'm glad we started there. But let's tie that to valuation. You know, the general idea of multiples is really the essence of what you're describing. When we think about it mechanically, we're going to have, you know, a numerator, the value or the output we

expect, and then a denominator, which is the thing at the aspect of the company that's going to be on a recurring basis, whether that would be, you know, something like earnings, or if you're looking at cash flows, whatever else, like what's the output? What does the company do on a recurring basis. And then the value of a company, whether it's the total value of the company or the value per share or whatever else, should definitely be a function of what that company does on a recurring basis or what we expect that company to do on a recurring basis. And if you expect that to grow a lot, you'll put a higher value on that, a higher price tag on it, similar to, let's say, maybe you expect greater results from someone who is extraordinarily committed to exercise or

extraordinarily committed to playing the guitar two to three hours a day versus someone who perhaps is less committed to playing the guitar watching a three-minute YouTube video once every other week. Yeah, that's perfect. Yeah, exactly. Let's try to make this easier though, because valuation can be intimidating. Once we start opening the Excel spreadsheet, things can get a little bit dicey for us retail investors, Patrick. Let's try to make it easy. How can we use historic market averages to make valuation, to make valuing companies a little bit easier for us? I think right now, Ricky, it's probably worth just mentioning that the mechanism or one of the forms of valuation I think might be useful for any investor, professional retail, just to

start thinking about valuation is the PE multiple, which is price to earnings or the stock price of a company relative to its earnings per share. And that's just a starting point. And if we're thinking about price to earnings, right, one of the things we can do as just a general reference point is to just look at what have price to earnings ratios been across the economy, you know, across time or last 30, 50 years. And generally speaking, they hover around 20, 18 to 20%. So that is not the, you know, the completion of valuation. But if once we start talking a little bit more about price to earnings ratios, I think the first reference point is just, okay, so in general, how has the market priced most stocks relative to earnings across time? And that's

roughly 20 times or the stock price is going to be 20 times each annual amount of earnings per share that that company can create. And some companies are able to maintain a much higher price tag for an extraordinarily long period of time. We can think about a company like Disney, which despite its recent issues with leadership questions about streaming, that sort of thing, it still has traded, for a long time, it's traded above a higher than a 20 times earnings price tag. And then you can also think about some manufacturing companies, I'll throw General Motors under the bus here, that have traditionally traded a lot of these car makers lower than the traditional market average. But this, I think, it's a good starting point for investors.

I'm going to break away from the outline I gave you earlier. This is on purpose. Price earnings to earnings multiples often get a bad rap because it doesn't, I've heard investors say it doesn't really tell you anything because for young companies, they're sort of inscrutable and there's so many adjustments that companies can make to their earnings to make them appear better than they are. That's sort of a cynical take, but do you think the price to earnings multiple is deserving of the bad rap it gets from some of those on a, I'll blame FinTwit. Okay. I actually first want to somewhat agree with that and then also disagree. I would say, first, I would agree with the criticisms, to be clear, I guess. I agree with the criticisms in that using a price-to-earnings multiple is not completing valuation. And when we find one company that's, you know, significantly lower than average or significantly higher than average, I just want to, you know, very aggressively caution, like, that's not the answer. That's not valuation. We cannot say that this company is trading at, you know, only 10 times earnings. Therefore, it must be undervalued because that's less than the average or another company that's trading at 40 or 30 times earnings must be overvalued.

I think that's a huge flaw of thinking of a price to earnings ratio as the end result evaluation. Rather, I want to emphasize that, no, price to earnings multiple is like a beginning, one beginning, one very useful reference point to think about what the company is, what they're worth, what the market is valuing that at the moment. And so with that lens, it's the starting point to valuation. Hey, why is it's the starting point for these kinds of conversations? Why is it or what is the market pricing? Why is it that the price to earnings ratio would be higher than average? You know, are there fundamental reasons related to the company's performance that will be less than the market average? So it's the starting point where we can start to flesh out those conversations about companies. So that's where I would say using it as the end result, I want to agree with the criticism, right? That's going to be flawed. That's really not the point. But disregarding it because of that, I think, would also be kind of going too far. If I can jump in just to keep this conversation going, I think the other comment you were making was more about, hey, but aren't there flaws with earnings? And wouldn't that, you know, be an incremental reason or challenge to using a price to earnings multiple if the denominator is something that we might find flaws with or tend to criticize.

And I'd argue we do have to be careful with earnings. We don't just want to accept that as, hey, just because it's reported, everything's good and representative. But at the same time, the fact that there could be issues is less of an issue because we're not really saying valuation is done given a price-to-earnings ratio. What we're really trying to figure out is where will their earnings go and how will price move alongside those earnings? And so those shouldn't be based on even what the company's doing alone.

It should be our own forecast of how we think the company should do going forward. So the earnings that we ultimately care about when we're building valuation, whether it's a massive discounted cash flow valuation model or using a multiple or whatever else, it's still based on our projections, our projections of what we think will happen. So I have this price to earnings multiple for a company, this point in time, the price tag that investors have given to a stock. what are some places that investors should look next if they're saying, you know, is this thing undervalued? Should they be looking at revenue projections? Should they be looking at historic price to earnings multiples to see what this company has done in the past? Where should they look? Yeah, I think the first thing, just to repeat your point, is like, first, just figure out, you know, what right now, what is the P.E. ratio for the company? What do I think about that?

How is it compared on average? Second thing I would start doing is just making sure that your denominator, your earnings, is representative. And the term I use is just the idea of core earnings. So in the denominator, you want to make sure that the price-to-earnings ratio is not too high or too low simply because earnings for that particular period or the trailing 12 months are non-representative. For example, there was a large one-time gain or a large one-time loss or something like that that is included in earnings or net income, but just sort of naturally wouldn't be a recurring event. So the first thing I would say is just understand what we're looking at right there in that moment in time to your point, Ricky. Are earnings representative? And

if not, I would say we can just adjust out the items that we think are truly one-time or truly non-recurring. Again, not to complete valuation, but to make sure that our initial reference point is kind of a valid one. And that could be something like a company has made an acquisition that they paid a lot of money for. I'll use Lululemon with the mirror acquisition. And then they have to write down that acquisition and then you see adjustments to a company's earnings, right? Yeah. In that particular case, I would say it's the period of the write-down would be the one that has like a little bit of a wonky impact on the earnings, not actually necessarily the period of the acquisition itself. The acquisition would change the financials, but wouldn't necessarily

change the earnings in the period of the acquisition. And what we're trying to bring this back to when we think about valuation and a company's earnings, and if it's undervalued, overvalued, if you buy stock, is you're trying to think about a company's value drivers. What are the things driving the value of this company? It's a fundamental question, but how can investors think about value drivers for companies? I think that's really where we want to spend our time. I mean, so far, we just kind of talked about getting a reference point and everything else. We want to spend our time on figuring out value drivers. And ultimately, valuation conversations about companies, right? This

doesn't extend all asset classes. About companies is a conversation on revenues, expenses, and then risk. Let's focus on revenues and expenses. What are your main drivers of performance, your main drivers of cash flows or earnings? They're revenues and expenses. And how can those things drive value? Well, we're trying to figure out, you know, what could drive revenue? What's the ways that it could grow over time? And then expenses aren't really the driver of value. The drive our value would be margins. And so the way we can think about that is, okay, so how can my expenses change in relation to revenue such that I could get margin expansion or possibly, you know, another way, margin

contraction? So the biggest part of valuation is doing our best to figure out what would drive revenue going forward and how do expenses work alongside that? Do we have opportunities for economies of scale? Do we have opportunities for margin expansion? You know, and what would be the reasons behind that? Why not spend a lot of time thinking about risk then? You said it's revenue, expenses, and risk.

Oh, sorry. I didn't mean to downplay that as don't think about it. I would argue, though, that the risk conversations are extremely important. But in some ways, they can actually be weaved into, and this is hard to do because we're going to get pretty qualitative here right now for a second, but your risk conversations can be woven into your conversations on revenues and expenses. What are the risks the company faces? Well, one of the main ones is that revenue won't be as big as expected or as big as the capital they've deployed, or it won't be big enough to cover their expenses such that they might operate at a deficit in terms of revenue being less than expenses, which could translate to an inability to generate enough cash flow.

So risk is extremely important, but risk really is how is the company going to perform in its core business, its revenues relative to its expenses over time. So certainly worth considering. Hopefully, when we're looking at our projections of revenues and expenses, we are thinking about, I guess, first and foremost, what could go wrong and why? What are the additional threats and competition that could come in and change this? And then also, what mistakes could we make? What are we overlooking? What other aspects could enable our projections to not turn out the way that we are expecting or maybe a rosy picture that we're hoping to present? Yeah. And I think that's also the case to build multiple scenarios in a lot of ways. So a lot of times with risk as well, for companies, it can be geopolitical. So we think about EV makers right now. Nissan recently reported today saying, we didn't sell as many electric vehicles in China as we expected. You might see some of these geopolitical battles playing out. It's hard to model. If you're thinking about a company like Taiwan Semiconductor, yes, it supplies the world with microchips, but you have a geopolitical risk between Taiwan and China, and that can be

intensely difficult to predict within an Excel spreadsheet. I want to boil this down. When we think about the Standard & Poor's 500, if someone's just buying an index fund, what are the fundamental value drivers for the Standard & Poor's 500? In general, if you're making investment in equities, the Standard & Poor's, the general market index, you're expecting that the economy will grow and the companies that represent that index are going to grow alongside the economy. And so that growth is going to include inflation. It's just going to include that companies overall will continue to perform. We'll have some rent earnings growth. We'll be able to grow alongside the economy. So that's just a starting point that an investment in equities does involve an

expectation of growth. It's not just, I'm going to make my investment to preserve my capital. I'm doing so with some risk and some expectation of return. You've got to try breakfast at A&W. You've got to try breakfast at A&W. And what better way than with a delicious Pret organic coffee? Starting at just $1 all day, every day, now until December 31st. You've got to try breakfast at A&W. At participating A&W locations in Ontario.

Let's bring this to a few companies to talk about value drivers, to talk about the expectations for margin, revenue growth, that sort of thing. One you wrote about was Walmart. And at the time that I wrote this outline, it could have changed by the time we're recording. It trades at about 43 times, four or three times trailing 12-month earnings. This is sort of surprising for a company that in a lot of ways functions like a utility. If you look at a company like Kroger next to it, it's significantly discounted compared to a company like Walmart. And you sort of make the case that investors may want to think about how Walmart could double their earnings to justify this stock price. Why do they first, before we talk about the scenarios in which they could or could

not do that, why do investors need to think about how Walmart, this behemoth, could double its earnings? Great. I think that starts back to our conversation on their PE ratio. The PE ratio, that's a pretty healthy valuation. I don't think anybody's debating whether or not Walmart's going to stick around or whether they have some stability, but they're not being valued right now as just a regular stable part of the economy. They've got a bit of a premium attached to them. So what does that premium mean? I would interpret that premium, the 43 times PE ratio is, if you want to make that investment, we have to be expecting earnings growth that's greater than your average or representative company in the economy we we we have to have that expectation

our expectation could be wrong but that's our reason when we're going if we think about investing in a company like walmart which has already proven itself in many ways so this is not a startup where we're trying to figure out if they'll be profitable whatever else it has to be based on hey they have positive earnings they've had for a long time and i'm certain they will continue but the challenge is will they grow right which i'm not saying i'm certain at what level But like Walmart is not going to be going bankrupt. But will they grow and at what rate? And so that healthy valuation implies they need at least some meaningful amount of revenue growth and likely also some degree of margin expansion to tie out or rationalize that kind of healthy valuation. So going forward, they need to, they've clearly performed well in the past, right? That's a given.

We know that. But going forward, they have to continue to outperform in terms of just a general or representative company in the economy with respect to their earnings growth, driven by future revenue and to our future margin expansion. And it's worth asking how they could do that. It would be difficult for a company like Walmart to do that on a grand scale, a company that's known for its everyday low prices. It doesn't want to just dramatically raise the prices of its groceries and goods on its customers because that in and of itself is its competitive advantage.

That revenue growth becomes difficult and also as a physical retailer, margin expansion becomes also very difficult. I think it's worth thinking about what levers Walmart has to increase its earnings per share when dramatically increasing revenue is difficult and also dramatically increasing margin because it keeps prices low is difficult. outside of just decreasing its share count, which can be a very effective tool for a mature company like Walmart. Yeah. And I actually want to orient back to the, you know, what should we be thinking about in terms of our investment? Let's just leave out, you know, changing the denominator to other factors, any form of financial engineering, not because it doesn't exist, but let's focus on their core operations. And so how could they do this? And Ricky, I love the way you set that up for this reason. Like, this is what we need to do with valuation,

just start having conversations. And the end we might answer be, I don't know, or I can't take a position, but start these conversations. Well, if this could happen, then what's the pushback? So let me try to just give potential scenarios here. But again, there's no certainty in any of these. I don't think the revenue growth just has to be explosive, but it has to be consistent and steady and decently high. So the challenge there is they're at $650 billion of revenue. So that thing has to keep moving up. They cannot rest on their laurels in terms of, we've done so well. The second one, margin expansion. I think you laid that out perfectly. And Costco is such a good example of this, where similar to Walmart, although slight differences, they're very clear

they're not going to raise their prices. And I think Doug McMillan has stated a version of that in different forms, the CEO of Walmart. So this cannot be from, hey, let's just increase prices and pass it on, hope nothing happens. I think that's just good business sense. So what could it be? Well, I think that we have to think about what are the investments? How is Walmart changing its structure, its operations. One, they have been moving towards more automation in their factories, their supply chain. When and how will those cost efficiencies come about? I don't know, but that's a possible lever. We want to think about how much of their expenses, as long as they keep growing revenue and as long as the world changes and they make different

investments, in the long run here, how can they improve, reduce expenses, not by increasing prices necessarily, but by getting more efficiencies in that massive supply chain that they run. Second point here, which I find fascinating is their advertising business. So their advertising business is three to $4 billion, something around there. It's really small for that big of a company, but it's an interesting one because that's an opportunity for margins that would be very, very, very different from the margins they have in their traditional retail. So as that grows or as that kind of changes or as the equilibrium of which Which companies, which consumer product companies, you know, who do they pay?

They're not going to be paying cable TV and traditional forms of advertising in the past. Like, does that shape the role of Walmart, specifically when Walmart's more of a platform with its website? So how will that grow? What are the margins of that? And I would argue on top of that, like, what other forms of new aspects of their business can they introduce to sort of gain that margin improvement? Because I really agree with your point that, you know, hey, I mean, could they increase prices? Sure. Would that be long run beneficial for them? Almost surely not. So I think it's more of a new lines of business, specifically things like advertising and then also opportunities within their supply chain to, you know, to really use or to gain more efficiencies. And the last thing I'd offer is retail is changing so much. And so I think you have two behemoths. You have Amazon, you have Walmart. And those two companies are showing that they can do things at scale that most others can't, including shipping things to our home. So as they get better at it, as they get bigger, do they actually not just sort of gain their own general efficiencies, but does that give them an ability to actually push so far as to wipe out some of the competition? And then, you know, that's sort of an incremental form of them to grow in that the consumer demands, you know, convenience.

We want certain items we want. We don't want to pay extra for it. And would this be an environment where, you know, the biggest have a incrementally beneficial advantage? And those are ways it can do it. And if it does, it may not need to double its revenue if it can maintain a loftier valuation than that historic average of 20. And it would do that based on investors in the future continuing to think that Walmart's growth prospects on the things that you just described are continuing further into the future. I think you brought up one of the risks as well when you were discussing the opportunities, and that is within its new lines of business. You could see a company like Walmart going more into something like healthcare, which has tripped up a lot of retailers in the past. And as these businesses expand, even as mature businesses, they risk de-worsification and adding in a bunch of new businesses that take away from the business's fundamental ability to drive value for their shareholders. I think that's a great point in that, yeah, an acquisition alone is not a guarantee that you'll have a value driver.

An acquisition makes you bigger. And you were talking about Lululemon. An acquisition makes you bigger. It's not necessarily, or a new line of business does make you bigger. That's not necessarily going to create value. Now, I'm not saying it'll destroy it, but hey, think about the risk and the opportunities that you just laid out. Let's move on to NVIDIA, which more than Walmart right now has a loftier valuation. I think it's about 65 times earnings. And at this rate, if it goes back to that 20, this mantra of the episode of that 20 times earnings baseline, which it may or may not within the next five to 10 years, depending on how much it's able to maintain its competitive

advantage on chip design in building these super fast systems on which these large language models run. What expectations are you seeing baked into that 65 times earnings valuation or price tag, PE price tag for NVIDIA? Great question. I included my conversation on Walmart and NVIDIA mainly just to show that you could take the framework evaluation and apply it to anything. So these are vastly different, vastly different companies. And man, the uncertainty with NVIDIA is massive. But let's just mathematically talk about what needs to happen here to tie out this valuation. It's a lofty, high valuation. NVIDIA, like Walmart, not the same track record across time, but has performed phenomenally well in the last couple of years. So relatively recent,

you know, explosive performance, but have crushed it. And what do they have here? Well, they still need, you know, this, the massive earnings growth and their potential of doing that, I think is very high. Our question is at what level, you know, so will they keep growing? Are we still in the early innings of the products we're selling? Yes. But the challenge is, you know, how high, at what level and what rate? And that's just a question that involves so much uncertainty, early equilibrium in the industry. Let me actually directly tie that to their margins. Their margins are amazingly high. And by that, I want to talk just their operating margins. So not some embellished version of it, but revenue minus all their core operating expenses.

They're still absurdly high at this moment in time. The challenge there is that that's effectively a margin that results from an industry with effectively no competition yet. But those extremely high margins are exactly what's going to attract new competition. Everyone's going to look at that and say, I want a piece of that. I think their compute network margins in the last quarters, that segment of their business, the main segment of their business, were 71%, 72% operating margins. That's crazy, but that's also amazingly attractive to anyone else. What does NVIDIA need to do? It needs to have a future that maintains its leadership to tie out its valuation, that maintains its leadership, which translates to it's still going to have

very high, very healthy revenue growth. And alongside that, be able to achieve that revenue growth without having to do anything like drop prices or change in customers that are going to require them to drop prices. So effectively to maintain their margins. I don't think they necessarily mathematically have to maintain exactly their margins, but they still need very high margins and the long foreseeable future about meaningful growth. But at the same time, right? Tons of uncertainty here, but you know, they are still so the, their industry they're in and they're dominating is still so new. We don't really know what's going to come next, how big this will be. So this is one that's an amazing conversation. I would argue everyone should think

about it and have it, but not one that's going to give us, you know, I love your comment earlier about Excel. Like there's no single, you know, line or, or set of formulas we're going to put in and be like, that's Nvidia's valuation. That's what they should be worth. That's an unknowable thing right now. I used your model on Netflix right now too, because I think Netflix is a company that is really interesting to talk about value drivers. I know you had a conversation about it back in 2022, where people were, I would say, thinking more about the risks that were happening for Netflix, especially after it had its subscriber drop. But I got to this place because I was like, man, this stock, I was just looking at the price. This is a bad thing to admit to a

professor of finance and accounting at the University of Texas McComb School of Business. But I was like, man, this price has really run up. I'm getting a little itchy on it. And what I did is I put it through the model and it made me think like, okay, what multiple do I have to expect on Netflix for it to maintain its share price today? What kind of revenue growth would that um would that require and what is the potential uh mispricing here and it sounds it sounds like a lot but basically if netflix is able to do a cumulative revenue growth in my mind of 100 which is about um 11 i i know we're doing a lot of math i'm sorry to the listener 12 over six years gets you to about 100 revenue growth and it needs to maintain a higher than market

average multiple, then you might have a mispricing and actually Netflix could be undervalued. Now, if competition heats up, if the market assigns a lower multiple and its revenue is not able to increase at that rate, then Netflix stock actually right now would be really overvalued. So right now, I think there's a lot of questions about Netflix's value drivers, especially as it pays more for content licensing, as it starts looking for more subscribers in the ad tier, and as it starts to look at more emerging markets where it's not going to be able to charge $20 a month. So how are you thinking about value drivers for Netflix right now? Yeah, that's a great question. A couple things there. And I think

you and I have talked before about just the role of the footnotes and the information you can pull out of that. So I mean, what you're offering is definitely worth considering. I want to add in one more thing. I think there's a little bit of margin expansion that they can still get in that they already have that to a certain extent over the last couple of years, they've improved. And then particularly through their third quarter of 2024, I think they're sitting at about 20%, sorry, 30%. That matters here. That's a big mistake. 30% operating margins. So they have had operating margin improvement. And let me just walk a little bit through that. As their revenue grows, they're a company that should get some margin expansion. One,

the cost of revenue is basically the main component of that is the amortization of the content assets. But as you have more people subscribing and paying really at any rate, right, you can actually sort of spread that out. So it's just a classic, like, you know, I have a cost allocation, I got a fixed cost, I spread it out a bigger base, in their case, subscribers, I should get some margin improvement. Now, to be clear, that margin improvement is not going to be some explosive thing, but they do have a chance to consistently grow their earnings or another lever, right, another lever they could grow their earnings with is with margin improvement over time. A variety of their expenses have a, relatively speaking, more of a fixed cost

component. As revenue grows, they should get some margin improvement. But again, I wouldn't expect that to be explosive. They've had that before. So that's, I think, another level I want to offer to your conversation. And then I want to push back a little bit on the revenue growth. A challenge to them with revenue growth might be just that they've had it. I hate to say this, it's like it's their success. It's an amazing company, let's be clear. But it's like they've also been really really successful at you know in 2022 like they got we just we hammered them the stock dropped i think i don't know what it was but dropped below 200 share i was buying at the time i'm supposed to disclose that during the sort of the drop in 2022 but the uh it at that point we're

like well their subscriber growth is going to go down and they're really going to struggle here and they you know they they change things they drop the sharing of accounts and i think we all grumbled for a little bit but then we went back that that was a great thing for them but the challenge going forward is in their, they have a footnote where they've described like their subscriber growth across all of their, it's the revenue recognition footnote. They describe their subscriber growth across all the different global markets. And we've seen a lot of that growth already come back. And so the challenge isn't, you know, do they have the ability to retain subscribers? I think the answer is definitely yes. It's, but have they sort of baked in or

already received the benefits of a lot of the growth to date. Not a knock at all, but at the same time, it's like, well, the more growth you've had in the past and the closer you get to market saturation, doesn't it make it harder to keep growing going forward? So I will push back on that one time and then I know we'll wrap up in a little bit. It may not be able to expand subscribers quite as much, but I think it will continue to have pricing power. Similar to what um spotify did when it introduced audiobooks onto the platform and then it was able to raise prices you know and then it's become sort of this free cash flow engine since then netflix may have a similar opportunity as it continues to introduce live events onto the platform where they've

started with um the the nfl football games and then they also uh on christmas day and then they're also bringing the wwe onto the platform which is it was the largest like the wwe monday night raw was the largest cable show. So if you're a fan of that, maybe they'll increase prices and then you can keep your live stuff and they may have an offering then where, hey, you can bring the price back down,

but then you're going to lose these live events that maybe you really like and enjoy. Last thing on that where they could expand is it's in the places we don't expect. This was a DVD mailing company. And while they haven't gone to theaters yet for releasing movies, this is becoming more and more of a media company.

And right now they're exploring getting Greta Gerwig's Narnia movie onto IMAX screens. So maybe they'll double back on that similar to the way they have with the advertising platform. So I guess I'll just push back and say, I don't think it's just the subscriber count that will drive Netflix's continued growth, especially in its big market of North America. I completely agree, Ricky. So I'm not going to push back on your pushback. I'm just going to go with you there. Push back on the pushback. And add a little bit, but I think that's a really good perspective, which is that whole thing with loss of subscribers than us eventually crawling back, I think they knew all along that was going

to happen as in, you know, what do we have? I think the amount of time the average user spends on Netflix each week is quite high. And I'd argue really independent of the live edition, which is a great comment, is that at the same time, this is probably a price insensitive customer. Let's go back to the, you know, the 80s and the 90s when we're paying for cable. We're paying 200 bucks a household in the u.s for no control over the timing you know far less content because it was only on at that moment in time and not all these other options and so if we were paying that much and i do understand netflix not the only streaming service people subscribe to but like in the long run and i'm sure they'll figure out this slow and steady way to do this because you

know if they double subscription prices that would this would fall apart but i i think there's another lever is the i completely agree with you the opportunity to increase because the consumer is likely price insensitive, as long as it's slow and steady. And then as they change and add offerings to the platform, that should be valued to us. If that's valued to us, they should be able to increase prices. And the last thing I'll say, which actually consistent with your point is, you know, advertising, you know, to what extent is their ability to actually generate revenue from, you know, companies, not from their subscribers, another possible lever. So, I mean, this is a great conversation as a reason. That's what valuation is. Have these conversations, lay

these things out. Try to tie it all back to what could grow their earnings. But I don't mean earnings in an isolated sense with the P.E. ratio or that that's the end of the final part of a conversation. It's think about what could drive revenue. Think about what would their expenses or how they could improve margins. What would be the reasons for that? And try to think about how those conversations work out over time. And that's that's valuation. Right. Begin those conversations. Is there a certain or definite answer? Almost surely not. But hopefully you can flesh it out and engage in conversations and at least, if nothing else,

like, you know, a starting point to consider should I or should I not invest in something. As always, people on the program may have interests in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content

follows Motley Fool editorial standards and are not approved by advertisers. TMF only picks products that it would personally recommend to friends like you. I'm Mary Long. Thanks for listening. We'll see you tomorrow. Thank you.