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Scary Valuations for These Two Companies

Netflix and Constellation Brands offer more trick than treat at today's prices.

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Jeremy Glaser: It may be Halloween but some of the scariest things we've seen recently are not trick-or-treaters but the valuations on Netflix and Constellation Brands.

It's not that we don't like these businesses. In fact, they have narrow moat ratings, meaning both should be able to fend off competitors for years to come. At the right price, we'd be happy owners, but valuation matters. Spending too much, even on a great business, is not a recipe for investment success.

In Netflix's case, analyst Neil Macker thinks the market is underestimating the margin pressure the online streamer is likely to face. Management sees the biggest driver of subscriber growth these days being excitement around original content. But this content isn't cheap to produce or procure, and the firm will have to keep ramping up spending to offer something fresh for viewers. On the other hand, the pushback seen when Netflix raised the prices on its grandfathered accounts and slowing user growth in the U.S. is a sign that don't have a ton of room to increase pricing without seeing an exodus of users. Macker sees this setting up a margin squeeze where Netflix will be spending more on content while not being able to push higher prices.

Adam Fleck thinks Constellation Brands has built its moat on the back of the U.S. beer market with brands like Corona and Modelo Especial, but that doesn't mean there isn't risk for the company's outlook. He points out that its wine and spirits business has less consumer loyalty and that the firm will have to invest in increases to brewery capacity which could be a drain on free cash flow. Fleck expects the firm's probability to rise over the next decade and for revenue growth to rise too, but thinks the market is just too optimistic today.

Jeremy Glaser does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.