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The Netflix sign on is shown on an iPad in Encinitas, California, in this file photo from April 19, 2013. (MIKE BLAKE/REUTERS)
The Netflix sign on is shown on an iPad in Encinitas, California, in this file photo from April 19, 2013. (MIKE BLAKE/REUTERS)

STRATEGY LAB

Scared by tech stocks’ drop? Think long term Add to ...

Chris Umiastowski is the growth investor for Globe Investor’s Strategy Lab. Follow his contributions here and view his model portfolio here.

The last week was a busy one for technology investors. Many of the large-cap stocks in my Strategy Lab model portfolio reported earnings. Yet I’m not remotely interested in the typical micro analysis of quarterly earnings and how they compare to consensus estimates from Wall Street analysts. I’m much more interested in the bigger, long-term picture.

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With that in mind, I thought I’d take a look at what’s happening with Facebook Inc. and Netflix Inc., the dominant names behind how people spend time on their small and large screens, respectively.

Netflix reported very good numbers, having added four million new streaming video subscribers in the quarter. They now have over 48 million streaming customers, and less than 13 million of these are outside of their traditional U.S. market. When Netflix started expanding abroad, it always said its strategy was to make new markets profitable and then immediately continue the global expansion. Impressively, Netflix disclosed that it is on track for its entire international business to reach profitability this year, which means we should expect another big wave of expansion. I look forward to seeing how quickly Netflix can bring its service to new parts of Europe and even Asia.

Netflix also announced plans to increase pricing by a dollar or two per month in most markets. Considering how cheap a Netflix subscription is, and the value one gets from it, I doubt this price hike will harm demand much. Yet in the long term, it should raise revenue as much as 25 per cent, money Netflix plans to use to increase the number of high-quality original productions it brings its customers. Content-wise, Netflix is becoming more like HBO, except that HBO has 130 million customers around the world and Netflix is only closing in on 50 million. There is a lot of growth left here. I’m excited about the long-term potential of my investment.

While Netflix showed us the growth coming from the big screen in our homes, Facebook showed us just how great a job they’ve done to monetize the little screens, otherwise known as tablets and smartphones. Two years ago, Facebook hadn’t even tried to show ads to users on its mobile apps. But today? A whopping 59 per cent of Facebook’s advertising revenue comes from smartphone and tablet users. This metric has steadily increased every quarter, as has the number of mobile monthly active users, which is now over one billion.

In the past couple of months technology stocks have, in general, posted sharp declines. Netflix dropped from over $450 (U.S.) to about $322 . Facebook was in the low $70 range and has now declined to about $57. While many investors will still argue these are expensive stocks, I’m think it’s times like these that enable investors to profitably build their long-term portfolios.

Netflix plans to produce 15 to 20 original shows per year while still having a huge library of licensed content. Even if the average customer only cares to watch five of these original shows, the subscription cost of Netflix is a no-brainer. I’d be shocked if Netflix doesn’t successfully expand to 200 million-plus users in the next five to six years, with at least a 20-per-cent operating profit margin. It isn’t difficult to imagine a scenario where Netflix stock doubles or triples from here.

Facebook seems like an even more compelling stock, given the recent price decline. Those who aren’t looking far into the future may not agree with me, considering the stock trades at about 40 times this year’s earnings estimate. But consider the rate of growth. Facebook just posted 82-per-cent year-over-year growth in advertising revenue for the most recent quarter. We all know this rate of growth will slow and that eventually Facebook will be a mature company unworthy of such a high multiple. But I believe there is still a lot of money to be moved into digital advertising. Facebook, like Google, will benefit. I think Facebook has much more growth ahead such that even as the price-earnings ratio declines in time, the stock will still appreciate significantly.

Great quality stocks often go on sale, and I think we’re witnessing a great sale right now. If they fit into your portfolio and if you can smartly take a long-term perspective on growth and industry change, I believe Netflix and Facebook are two stocks worth looking at right now.

The author owns shares in Netflix and Facebook, both personally and in his Strategy Lab portfolio.

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