Netflix (NFLX, Financial) shares moved higher by 1.38% on Monday continuing a strong period of recent performance that has seen shares soar by 65% year-to-date and take out the $550 level for the first time.
This strong move higher appears to be a direct result of investor exuberance, much of it irrational, as investors look for reasons to build "castles in the air." Here's why:
Earnings
Netflix shares surged higher on heavy volume earlier this month after the company reported earnings to market. Investors were bouyed by record numbers of international subscribers to the video streaming service.
However, earnings were not all that good. Foreign exchange pressure has put a dampener on earnings and as you can see by the following chart, EBITDA growth has stalled while the share price continues to soar to new heights.
This is reason number one, why investors are acting irrationally when it comes to pricing Netflix stock.
Volatility
Another bad omen for Netflix is that the stock is now highly volatile. According to my own custom algorithm that measure short-term volatility, Netflix is now the seventh most volatile company in the S&P 1500 universe.
This can be seen by looking at the price chart where there are lots of gaps and many periods of unpredictable price moves. According to my back-test results, companies that rank in the top 50 in terms of volatility have gone on to return less than 1% a year over the last 20 years.
So the stars are not looking particularly good for Netflix investors at the current time.
Momentum and hidden risks
The one thing going for NFLX investors at the current time is momentum. The stock is riding a wave of investor euphoria that could easily continue for another couple of days if not weeks.
However, any further out than this, and the picture looks considerably less rosy.
The stock ranks as one of the most overpriced stocks in the market according to it's financial ratios, trading at a price-to-earnings in excess of 100 with a PEG that is over 3.
Nowhere is this more clear than the Peter Lynch chart, which shows a stock that is currently out of touch with reality.
This is the antithesis of the sort of a stock that value investors like to seek out.
Competition
Not only are the numbers expensive, there are a number of hidden risks associated with this type of company. It must be remembered that online video streaming is still in it's infancy and that Netflix's major disadvantage is that it must pay for it's content first.
This is unlike Netflix's major competitor YouTube, which gets an endless supply of free content uploaded to it’s servers every minute of the day.
Content is crucial in this industry and if Netflix is unable to stay at the very top in terms of content provided, the company's high-end valuation is in danger.
But, for investors, it is not content that is king but cash. And Netflix free-cash-flow is in a worrying downward trend.
Add to that, the threat of anti-freedom net neutrality rules in foreign countries (as well as at home) and it's clear there are plenty of risks associated with Netflix shares at the moment.
The company seems to have strong management in place, but at $565 a share, investors would be well placed to avoid this one investment opportunity right now.
Read more of my analysis and articles at: jbmarwood.com
