Investors in Netflix (NFLX, Financial) saw the stock drop over $100 per share last night in after hours trading. The stock actually pared its losses today as the company was down as much as 25% last night. Shares of Netflix dropped over 20 percent today as the company reported earnings last night. The Good News: Netflix’s revenue rose 27% to $1.41 billion, and EPS doubled to $0.93 per share. The Bad News: Netflix gained 3 million new subscribers when the company was expected to gain 3.4 million by analysts. The company had ambitiously targeted 3.69 million subscribers for Q3. Whether it was the $1 price hike or merely that growth is slowing, the company could not meet the expectations of the Street.
What would have been a good quarter for most growth stocks was a poor one for Netflix. Why?
Netflix was priced for perfection and is expensive based on any valuation that you use. Netflix is a great company who has had great growth prospects historically but the stock simply became too expensive. Netflix was trading for 140 times earnings which is ridiculous considering the 33% earnings growth rate. A value investor should pay no more than 1 times the earnings growth rate. Fourth quarter earnings estimates of 44 cents per share are substantially below the 85 cents per share originally estimated. The negative turn in free cash flow (-$74 million) should also be concerning.
I think that Netflix is set for a greater fall in Q4 as the company is predicting an even more ambitious number with 4 million subscribers being the goal. I have always avoided Netflix’s stock because the company lacks an economic moat. Netflix is basically a middle man that distributes content for media companies who create the content. It is only a matter of time before content companies either squeeze Netflix in pricing or choose to deliver their own content. Content costs have risen to nearly $9 billion dollars per year. Time Warner’s (TW) decision to deliver its own content via an HBO GO streaming service is just the start. CBS, Comcast, and Disney will all likely compete against Netflix in the future. Add in Amazon Prime and Hulu and the market is getting pretty crowded. A potential rise in future bandwidth prices could also depress Netflix’s bottom line.
Even at $360 a share, Netflix is still overpriced. The 108 P/E is still too high even if the company could somehow magically return to its 50% growth days. Expectations are still too high for Netflix as analysts are still way too bullish on the stock expecting the shares to rebound quickly. Goldman Sachs, BMO Capital, and Jannay Capital still have a buy rating on the stock. With the current market volatility, Netflix looks like a stock that short sellers will drop down to the $300 level quickly. A growth stock, which is seeing lower than expected growth that still trades at a premium valuation is more than what I am willing to pay.
