1 Reason Why Warren Buffett Would Like Netflix Stock, and 1 Reason He'd Avoid It Like the Plague

Warren Buffett, who is no longer the CEO of Berkshire Hathaway, built an incredible track record by focusing on what he believes are high-quality companies. There’s no doubt that Netflix (NFLX 2.38%), with its incredible growth, innovation, and sizable profits, falls into this category of elite businesses.

Although he never purchased shares, it’s still informative to put Netflix though the Oracle of Omaha’s tests. Here’s one reason he would like the streaming stock, and one reason he’d avoid it like the plague.

The streaming leader’s management exercised financial discipline

When Netflix agreed to purchase the studios and streaming assets of Warner Bros Discovery in December, I was surprised. The $83 billion initial terms (based on enterprise value) would’ve resulted in Netflix taking on a sizable chunk of debt. And it would’ve been the first sign of the business parting ways with its track record of organic growth.

On Feb. 26, Netflix bowed out of the acquisition race, avoiding a bidding war with Paramount Skydance. “This transaction was always a ‘nice to have’ at the right price, not a ‘must have’ at any price,” the press release read.

Assessing the management team is an important part of Warren Buffett’s investing process. And this partly involves looking at a company’s capital allocation prowess. The fact that Netflix walked away from a blockbuster deal, one that would’ve placed it light years ahead of the rest of the industry, is a clear display of financial discipline. When the numbers don’t make sense, it’s time to move on.

I don’t doubt that Buffett applauded this decision.

Being a value investor typically means staying away from high-flying names

Maybe Warren Buffett’s biggest legacy will be that he popularized the concept of value investing. Buying stocks for less than their estimated intrinsic worth has obviously worked out well for Berkshire Hathaway, as it has resulted in it being one of the few trillion-dollar companies out there. This philosophy naturally leads to the avoidance of high-flying names.

In the past 20 years, Netflix shares have posted an astronomical gain of 23,230% (as of April 17). While the business has established a dominant position in the streaming industry, the stock trades at a price-to-earnings (P/E) ratio of 38.5. That expensive valuation is why the Oracle of Omaha would avoid Netflix like the plague. He probably doesn’t think there’s a margin of safety.

Buffett’s best investment in recent memory is Apple, which the conglomerate first bought around a P/E multiple of 10.6 in the first quarter of 2016. By comparison, Netflix is simply out of reach for the legendary investor.