David Trainer, CEO of New Constructs, walks through their DCF model using Netflix as an example. The tool forecasts revenue growth, profit margins, and cash flow across default, neutral, and optimistic scenarios to calculate shareholder value per share.
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Hi, this is David Trainer, CEO of New Constructs. I want to show you today exactly how we, in our recent Danger Zone article on Netflix, how we use one of our models to show and calculate exactly how overvalued a company is. A lot of people talk about valuation, but valuation, you know, there's so many different ratios and methods for determining valuation that are shortcuts, and you can come to all kinds of conclusions depending on how you use those metrics. We use a discounted cash flow model, and that allows us to operate with a certain level of precision and transparency and ultimately peace of mind that we think is very meaningful. And today I want to show you exactly how in our report we point out the absolutely outrageous customer growth rates or subscriber growth rates that Netflix has got to achieve to justify the current stock price. So you go to our system, you type in the ticker, you open a model, and the first thing you'll see is that we have a default scenario here. And the default scenario is just based on what we believe to be the most reasonable, realistic estimates for the future of the business. It's just a starting point. The cool thing to do is, is to play with different scenarios. And here you can see the neutral scenario I've created. And you'll see that the blue line is the default scenario. The neutral scenario jacks up the revenue rates quite a bit, as well as the profitability, and shows that it takes about 20 years to get to the current stock price. Right? That's what we call expectations quantification. In order to justify $444.36, the company's got to grow profits at revenue— at a compounded revenue growth rate of 20.2%. The economic earnings margin has to be 4.4%, and it's got to do all that for 20 years in a discounted cash flow model to justify a price that's equal to or closest to the current stock price. The way we do that is by entering different scenarios on our forecast page. And here you just go to the forecast page, you click edit, and you forecast along 5 key metrics. Revenue growth is obvious. Pre-tax profit margin, or net operating profit before tax, is key. Cash tax rate is key. That's how you get to after-tax cash flow. We also require forecasts for working capital and fixed assets. Now notice I didn't make any changes to the default scenario here because I think those are good enough, but I want you to understand There's no such thing as a true discounted cash flow model that does not have forecasts for the balance sheet or working capital and fixed assets. We have that there, and we put in a different set of estimates or different margin here for the neutral scenario. You can also see I've put the growth rates up above the defaults versus the defaults scenario that are much higher, 20% growth out for over— for 25 years. And I did that because, well, I know that if I didn't, it would give me a sort of a super long timeframe to get to the current stock price. Now, the DCF page. This is the best DCF page in the business. You're not gonna see anything more explicit or more transparent than our discounted cash flow model page. It's gonna give you the ability to look at all scenarios, and you're gonna see that we get a multiple forecast horizon model here that gives us multiple values per share. Now I'm gonna switch to a PDF 'cause it's a little easier to follow. But you can see in year 20, that's the year in which we get a stock price in our DCF, a value that's equal to but still less than the current stock price. Year 21 in the model gives us $482. That's a little bit too high. You can see we've used 7.5% margin. You can see our working capital and fixed asset adjustments here show us how much capital is going into the business over this time frame so that we can calculate a true free cash flow. free cash flow number, right? We're still showing negative free cash flow for these guys as we have over most of its history. And we use all this at the end of the day again to get to a shareholder value per share. The implied revenue in 20 years is over $218 million. When you divide that by $8 a month or $96 a year, which is the current price for subscribers, you get 2.72 billion. That's how many subscribers the company's gonna have to have In order to generate $218 million in revenue. $2.72 billion, that's a big number. That's a really big number. So let's look at a different scenario. Let's try looking at what we call the optimistic scenario. And here in the optimistic scenario, really all I did is type in 15%. For the forecast there. So let's cancel that, go to Optimistic, edit that, and now you can see there's the inputs for the Optimistic. 15%, same tax rate, same revenue growth profile, same working capital and fixed asset profile as the other scenarios. So we're controlling for the margin here. That's the beautiful thing about our models. You can isolate any factor you want with respect to profitability. But the most important message being all the factors that affect profitability are covered here. Revenue growth, pretax profit margin, cash tax rate, working capital, and fixed asset needs. So when we go to our DCF, it's gonna choose the optimistic scenario here for us. And we're gonna see now that it takes about 10 years of profit growth at 20% compounded annually with a 15% margin, okay? Mm-hmm. And so, Let's look at a PDF here of this page as well. A little bit shorter, a little bit easier. But you can see here's the growth period, here's— or the growth appreciation period, the margin assumption. Here's the shareholder value per share, and we're at $429 here. Again, it's still less than, all right, than the current stock price. That's because in year 11 we jumped to $479. That's a lot, that's because you got such a huge growth rate here over time that the numbers are, you know, are kind of growing pretty drastically, I guess you might say. Again, we've got the working capital adjustments and fixed asset adjustments, right? With the higher revenue growth rate and the higher margin, your free cash flow margin actually is positive in this scenario. But at the end of the day, you still got to get to $35 billion in revenue. Now, if you're dividing $35 billion by $24 a month, which is our other scenario here, or $288 a year, you need to have 122 million in the number of subscribers that have to sign up, which is a huge number, okay? But that's of course more than double the 57 million in subscribers that they have. And the other thing you gotta keep in mind is if you're gonna be able to double your margin and triple your price, you know, that's a pretty hard thing to pull off. So, you know, we would suggest that it's probably pretty unlikely that that would ever happen. Well, let's say they doubled their price, and so instead of $96 a year, you're talking about $192 a year. And if we divide $192 into $35,227,000, $35,227,000 divided by $192, Well, that means you're gonna have to have 183 million users. And what we have, 57 million in the United States, we have to have 3 times the United States as subscribers. Anyway, the scenarios here and the different permutations are endless. But what's not endless is the transparency and the actual analytical rigor of what it is we're doing. So hopefully this is helpful. This is one way that we use our discounted cash flow model. Thanks, David. To show exactly how we quantify expectations and how you can really get a really, I guess, I like to call it discrete and transparent sense of how to use the model and how to understand the expectations baked into stock prices. Because at the end of the day, you want to buy low expectations and sell high expectations, and we like to believe that we give you the best models in the world for quantifying whether or not expectations are high, low, or just about right. Thank you. Thank you.
