I have been bearish on Netflix (NFLX, Financial) for quite some time now, and the primary reason for my bearishness has been the stock’s absurd valuation.
Although Netflix is a growth stock, I find its valuation illogical, and I am confident that the company will not be able to sustain it for long, which is why I recommended shorting the stock some time back. This conclusion is supported by the company’s latest quarterly results.
Netflix announced quarterly earnings earlier this week, and Mr. Market wasn’t happy. The company reported EPS of 6 cents on revenue of $1.96 billion. The company missed on revenue estimates by roughly $10 million but surpassed the earnings estimates by 3 cents per share.
For a growth stock that has been trading over 350x trailing earnings, a miss on revenue is always disastrous. And Netflix was no exception as the company saw its shares plummet 12% the following day. Despite strong subscriber growth, Netflix’s growth provided weak guidance for the upcoming quarter.
For the second quarter, Netflix expects to add 500,000 new subscribers in the U.S. and 2 million internationally. Analysts were projecting 586,000 domestic additions and 3.5 million international additions. Slowing subscriber growth spells trouble for Netflix investors as the company still has no significant earnings power.
The only reason why Netflix commands such a high earnings multiple is its growth. With growth slowing down a lot sooner than many investors expected, Netflix’s share price is destined to come back down.
Netflix is preparing to hike subscription rates in the U.S., which is why the company guided down for the subscriber growth for the second quarter. While rate hikes should boost Netflix’s earnings, it also points toward the fact that the company’s domestic business is maturing. Investors should be cautious about Netflix going forward.
International expansion won’t be successful
While Netflix is successful in the U.S. because of its cheap subscription rate, investors shouldn’t count on it to be successful in all other countries as well. For instance, countries like India have a lot less per capita income than the U.S., and cable TV in India is also a lot cheaper than in the U.S. I don’t expect Netflix to enjoy similar success in countries where people have less disposable income.
Conclusion
With Netflix’s domestic business already maturing and its international business showing signs of weakness, Netflix will not be able to sustain its current valuation, thereby making the stock a good short for now.
Disclosure: The author doesn’t have any position in the stocks mentioned in the article.
