In this article I use AAII’s A+ Stock Grades to provide insight into three online retail service stocks. With the recent reliance on technology, is it time that you consider these online services such as NetflixNFLX
, PinterestPINS
and SpotifySPOT
?
The world is becoming more digitally connected, so it’s no surprise that e-commerce sales are expected to exceed $1.1 trillion in 2023. However, for these companies, it is vital to stay ahead of the trends that are shaping the industry. Consumers are constantly turning to subscription services for convenience, value and personalization. The introduction of in-app purchases has made apps such as Pinterest and Instagram competitors in the e-commerce landscape.
How does the current state of the industry look? Consumers find themselves searching for a convenient way to buy products, either for practical use or for entertainment. Social media has become a gateway for online purchases. With 57% of consumers shopping internationally, online shopping has turned into a global industry.
However, some e-commerce companies face challenges when competing with big household retailers. One significant issue is cart abandonment. The biggest reason for cart abandonment is extra costs, including shipping, taxes and fees. The products being sold, along with additional fees, were affected by an 8% inflation rate in 2022. Inflation tends to impact consumer behavior and production costs. To cope with inflation, e-commerce businesses can stay adaptable to come out on top. As delivery methods become more efficient, consumers will opt for a quick and easy solution to shopping, since shopping can take a lot of time and effort.
Grading Online Retail Stocks With AAII’s A+ Stock Grades
When analyzing a company, it is useful to have an objective framework that allows you to compare companies in the same way. This is why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been shown to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.
Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three online retail stocks–Netflix, Pinterest and Spotify–based on their fundamentals.
American Association of Individual Investors
What the A+ Stock Grades Reveal
Netflix is an entertaining streaming service that provides access to your favorite movies and shows. With a monthly subscription, the service’s customers control what they watch and when they watch it. Netflix streams in 30 different languages and 190 countries. It also provides personalized recommendations for customers who struggle to pick something to watch.
Netflix has a Growth Grade of B, based on its Growth Score of 72. This grade considers historical growth in revenue, earnings per share and operating cash flow. Netflix’s sales have grown by an average of 22.0% a year over the past five years. The company has generated positive cash flow from operations in three out of the last five fiscal years.
Netflix has a Momentum Grade of A, based on its Momentum Score of 92. Momentum is based on the price change of a stock over a one-year period, creating a weighted average of relative strength over each of the past four quarters. The most recent quarter is weighted the highest, with each of the previous three quarters given an equal weighting. Stocks with high relative levels of momentum tend to continue to outperform. The company has seen above-average relative strength in three of its four latest quarters, with its second-most-recent quarter and fourth-most-recent quarter both ranking in the 90th percentile of relative strength.
Netflix has a Quality Grade of A, based on its Quality Score of 89. The Quality Grade is the average percentile rank of the percentile ranks for return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals to assets, Z double prime bankruptcy risk (Z) score and F-Score. The F-Score is a rank between 0 and 9 that assesses the strength of the company’s financial position. The Quality Score is variable, meaning it can consider all eight measures if they are all valid. To be assigned a Quality Score, stocks must have a value for at least four of the eight measures. Netflix has strong return on invested capital, ranking in the 91st percentile of all stocks at 73.5% versus the technology sector median of 19.2%. Netflix has an F-Score of 7, ranking in the 84th percentile, which exceeds the sector median of 4.
Netflix has a Value Grade of F, based on its Value Score of 16, which is ultra expensive. Its price-to-book-value (P/B) ratio ranks in the 91st percentile and its price-to-sales (P/S) ratio ranks in the 84th percentile of all stocks. Both are significantly above the respective technology sector medians. The company has an above-average shareholder yield of 0.2%.
Pinterest is a visual discovery technology platform that helps users find useful, relevant ideas and bring them to life. People do not always have the words to express what they are looking for. With content ranging from recipes to travel ideas, Pinterest appeals to a vast audience. Pinterest recently implemented online shopping into the app, enabling users to buy products on sight simply by clicking on a post or “pin.”
Pinterest has a Value Grade of F, based on its Value Score of 8, which is ultra expensive. The company has above-average price-to-sales, price-to-book and price-to-free-cash-flow (P/FCF) ratios. The company is overvalued based on these metrics, thus the low Value Grade and Score.
Pinterest has a Growth Grade of B, based on its Growth Score of 75. This grade considers both short- and long-term historical growth in revenue, earnings per share and operating cash flow. In the second quarter of 2023, the company reported a 6% year-over-year increase to $708 million. The company’s annual sales growth for the last five years is 42.7%, compared to the sector median of 9.3%. Pinterest has seen its sales increase year over year for five out of the past five fiscal years and it has generated positive annual cash from operations in four out of the past five fiscal years.
Pinterest has a Quality Grade of A, based on its Quality Score of 92. Pinterest’s Z-Score of 11.14 ranks in the 92nd percentile, compared to the sector median of 4.34. Additionally, Pinterest’s gross income to assets of 67.6% ranks in the 93rd percentile, compared to the sector median of 27.3%.
Spotify Technology offers digital music-streaming services. The company enables users to discover new releases, playlists and millions of songs so that users can play their favorites, discover new tracks and build a personalized collection. Its users can either select Spotify Free, which includes only shuffle play, or Spotify Premium, which encompasses a range of features, such as shuffle play, no advertisements, unlimited skips, listen offline, play any track and audio. The company operates through a number of subsidiaries, including Spotify Ltd., and is present in over 20 countries.
Spotify has a Quality Grade of C, based on its Quality Grade of 55. Spotify ranks in the 80th percentile for gross income to assets at 42.5%, compared to the sector median of 27.3%. Return on assets ranks in the 32nd percentile at -12.8%, compared to the sector median of -5.2%. Additionally, the company has a very low Z-Score of 1.73, ranking in the 23rd percentile of all stocks, and well below the sector median of 4.34.
Spotify has a Growth Grade of A, based on its Growth Score of 82. The company reported an 11% increase in revenue on a comparable basis for the second quarter of 2023, up to $3.17 billion. Spotify’s annual sales for the last five years rank in the 48th percentile at 23.5%, compared to the sector median of 9.3%. Spotify has seen its sales increase year over year and generated positive annual cash from operations for five out of the last five fiscal years.
Spotify has a Momentum Grade of A, based on its Momentum Score of 88. This means that it ranks strongly in terms of its weighted relative price strength over the last four quarters. The company has had above-average relative strength in each of the previous three quarters, with its fourth-most-recent quarter being the main detractor from its otherwise favorable performance over the past year.
Earnings estimate revisions offer an indication of how analysts view the short-term prospects of a firm. For instance, Spotify currently has an Earnings Estimate Revisions Grade of C, based on its score of 48, which is considered neutral. In its most recent quarter, the company had a standardized unexpected earnings (SUE) surprise of 4.6, ranking in the 78th percentile. The SUE score measures the number of standard deviations the actual announced earnings differ from the estimated earnings for a company. The company missed the consensus estimate by 145.3%, or $0.92 per share, generating this above-average SUE score of 4.6.
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The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.
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