Netflix Inc.’s (NFLX, Financial) blowout subscriber growth during the fourth quarter of 2016 has pushed its stock price towards new 52-week highs. The stock price has moved up by more than 65% in the last 12 months, with most of the surge occurring in the last few months. At seven times sales, Netflix’s valuation is obviously over the top, which requires investors to exercise plenty of caution and calculation before making an investment at this price point.
After the first and second quarter 2016 results were announced, Netflix stock was hammered as subscriber growth numbers were lower than expected.
According to CNBC, after first-quarter results "Netflix shares fell by more than 12% in after-hours trading." It was later able to recover some of those losses.
After reporting second-quarter results where subscriber numbers missed guidance, CNBC reported"Netflix shares dropped as much as 15% in after-hours trading."
It is clear the stock remains extremely volatile, moving at double-digit rates on the upside as well as the downside. If subscriber growth beats expectations, the stock skyrockets; conversely, when subscriber numbers fail to meet expectations, the stock plunges. One of the main factors behind the stock's highly volatile nature is the heavy burden of expectation the company continues to carry.
Trading at more than seven times sales at the time of writing, the stock has a lot of momentum. At these levels, any company would keep reporting above-average results. In the case of Netflix, subscriber growth has to continue growing at a rapid pace. If not, that downward pressure will rear its ugly head once again.
Netflix’s international user base seems to be on a roll. The company added a whopping 5.12 million subscribers internationally - much higher than the company’s forecast of 3.75 million additions for the quarter. Netflix now expects to add 3.75 million international subscribers in the current quarter.
There are several reasons that led us to believe the Netflix growth story still has a lot of steam powering it. The company has already expanded to 190 countries around the world, but still needs to establish itself strongly outside the United States. As brand awareness increases - along with its original content push - growth is bound to come.
But there is a caveat here: Netflix is not Facebook (FB, Financial). It is not an application that can keep adding user after user driven by the networking effect. Netflix’s product is content, so the company needs to create great content on a regular basis.
Although subscriber growth can stay on a steady incremental path, it is not going to be consistent. In fact, it is going to be very similar to what we witnessed this past year: bad first quarter, really bad second quarter, good third quarter and a mind-blowing fourth quarter. Due to the high valuation, every piece of news regarding user base growth will move the stock up or down in a strong fashion, which will continue for the next several quarters.
Entering at this point will leave your position vulnerable to bad news, which, as we have already seen, is inevitable. Netflix is a great company with a solid product. Competition has, so far, been playing catch-up with them. We believe it will remain that way for a long time because, for its competitors, streaming video on demand is not their main service. For Netflix, streaming is all it does. If you want to invest in Netflix, invest for the long term. Stay patient and wait for bad news before you add to your position, or buy small amounts over a long period of time.
Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.
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