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Better Buy: Netflix (NFLX) vs. Facebook (FB)

Brian Stoffel, The Motley Fool

Two of Wall Street's most popular names, Netflix (NASDAQ: NFLX) and Facebook (NASDAQ: FB), have finally taken a breather. In the three-year period(s) leading into their respective summer earnings releases, Netflix returned more than 300% to its shareholders, and Facebook returned 121%. In less than a month, however, the behemoths have collectively shed $135 billion in value post-earnings.

Does that mean they are good stocks to buy? And if so, which is the better stock at today's prices?

Businessman watching a movie with transparent tablet.

Image source: Getty Images.

Eighteen months ago, I asked the very same question, and Facebook came out squarely ahead. But much has changed since then. Let's see how these two stack up today.

Financial fortitude

As difficult a fact as it is to accept, the future is completely unknowable. Black swans can ruin even the most carefully laid plans. As such, financial fortitude is of the utmost importance. If chaos hit these companies -- or the macroeconomic outlook in general -- how would they fare?

In general, I like to classify companies -- relative to their balance sheets and cash flow statements -- in three groups: the fragile, the robust, and the antifragile. You can read more about these classifications here.

Keeping in mind that Facebook is valued at more than three times the size of Netflix, here's how the two compare:

Company Cash Debt Free Cash Flow
Facebook $44 billion $0 $19 billion
Netflix $2.6 billion $6.5 billion ($1.8 billion)

Data source: Yahoo! Finance. Cash includes long- and short-term investments. Free cash flow presented on trailing 12-month basis.

There's no doubt that Facebook has the upper hand here. Don't get me wrong; Netflix is definitely taking a wise approach toward developing its own content and expanding services abroad. But those investments cost a lot of money.

If no black swans hit and Netflix carries out its strategy perfectly, its investments will be well worth the risk. But if an economic -- or company-specific -- crisis hit today, Netflix would be in a very difficult position given its debt load and negative free cash flow. 

Facebook, on the other hand, could actually take advantage of such a downturn, given its stellar balance sheet and enormous cash flows. That's why even last month's bearish forecast only knocked the stock back to where it was just a few months prior. The company's strength gives investors downside protection.

Winner = Facebook

Valuation

Next we have valuation -- something that is part science, part art. To get a more holistic view of how "expensive" each stock is, here are three metrics I like to consult:

Company P/E P/FCF PEG Ratio
Facebook 28 28 1.1
Netflix 157 N/A 2.0

Data source: Yahoo! Finance, E*Trade. P/E = Price-to-earnings. P/FCF = Price-to-free cash flow. PEG = Price-to-earnings growth. Non-GAAP earnings used to calculate P/E when applicable. N/A = not applicable due to negative free cash flows.

On every metric, Facebook is the cheaper stock. This isn't too surprising, as Netflix has decided to pour most of its earnings and cash flow back into developing original content. That makes it tough to get a fair look at how much Netflix is really worth. If we base price-to-earnings on expected 2019 earnings, for instance, Netflix's P/E is cut in half -- to 76.

That said, Facebook's valuation is still more attractive, and the company gets the nod once again.

Winner = Facebook

Sustainable competitive advantages

Finally, we have sustainable competitive advantages, more commonly referred to as competitive moats. Moats are what allow companies to retain their customers over time, even as competition starts encroaching. Moats also enable the magic of compounding to continue uninterrupted for decades -- which is where wealth is truly built in stock markets.

Netflix's moat remains largely unchanged from the last time I ran this analysis: The company uses the power of its brand -- and original content -- to win over customers. Once in the ecosystem, switching costs are higher than you might think. Because Netflix's service is priced so low and payments are made automatically from your credit card, a portion of customers don't even notice the payments, whether they're using Netflix or not.

That's why the company's addition of more than 25 million subscribers in the past 18 months is such a big deal: Most of them are locked in for the long haul.

Facebook, on the other hand, has been assaulted on multiple fronts. Scandals over the handling of data in the wake of the 2016 presidential election and the resulting, growing costs of providing better security have taken their toll. Future acquisitions, in the model of Instagram and WhatsApp, are likely to be challenged by authorities in the future. This limits the company's potential to stave off user attrition to other platforms.

But because of a brilliant post by tech blogger Ben Thompson, I am convinced that Facebook's moat might actually be larger than I realized 18 months ago. Consider that the increased costs for security, for instance, will have to be tackled by anyone wishing to become as large as Facebook. Because of its industry-leading position and huge war chest, this is an enormous barrier to entry for any social media site wishing to challenge Facebook without running into the same security issues.

Furthermore, because a company's digital advertising campaigns can be managed across both Facebook and Instagram (and perhaps WhatsApp and even Messenger in time) on the same platform, there might be high switching costs for advertisers involved, too. What marketing department wants to manage their budget across four platforms when it can knock two or three of the biggest ones out from the same platform?

As such, I don't think Netflix has pulled ahead of Facebook's moat, and I'm calling this a tie.

Winner = Tie

And my winner is...

So there you have it; while both companies have formidable moats, Facebook's war chest and more attractive share price give it the upper hand. Personally, I own both stocks, but Facebook accounts for a much larger portion of my portfolio (roughly 7%) for the reasons given above.

If you're looking for a reasonably priced growth company, I believe Facebook is a great place to start.

More From The Motley Fool

Brian Stoffel owns shares of Facebook and Netflix. The Motley Fool owns shares of and recommends Facebook and Netflix. The Motley Fool has a disclosure policy.

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