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Netflix: Can This Fallen Angel Fly Again?

Netflix (NSDQ: NFLX) has been by far the best performer among the five-stock “FAANG” coterie in 2018. Over the past two years, NFLX’s share price has roughly  quadrupled.

Netflix started as a DVD rental by mail service; it’s now the largest provider of online video in the U.S. It pioneered the business model of subscription video on demand. The company licenses content from third-parties; it also finances and distributes its own content.

Netflix recently inked a high-profile deal with Sky, Europe’s largest cable TV operator. The partnership will make Netflix content easily accessible to Sky’s 22 million customers. Strong subscriber additions in the fourth and first quarters further lit a fire under the stock, as did a number of analyst upgrades. Investor enthusiasm has driven NFLX’s valuation into the stratosphere (see stock price chart):

The company has been on a creative roll as well. Notably, Netflix won the 2018 Academy Award for Best Documentary for Icarus. Although the company’s original content dominates the Emmy scene, Icarus was its first Oscar win, a huge accolade.

Too Close to the Sun

The Icarus of Greek legend flew too high to the sun, which melted his wax wings and sent him crashing to earth. Ambitious high-flier Netflix recently crashed, too.

When a stock is soaring based on high expectations, a crack in the growth story usually halts the rally. And that’s what happened last week. The stock finally showed some vulnerability, falling 5% on Tuesday after reporting earnings the evening before. Since then, the stock has slid further into the $360 range.

In the second quarter, Netflix added fewer new subscribers than expected. Wall Street expected 6.27 million, but the company reported only 5.14 million. In the preceding two quarters, the company averaged 7.9 million new additions and blew out expectations each time, so the second quarter was quite a change in tone.

Netflix spent $6.3 billion on programming in 2017. To hang onto its position as a leading video-on-demand provider, Netflix needs to keep spending money to acquire content to retain and attract viewers.

This year, the company plans to spend up to $8 billion to acquire content. This would be more than any other Internet streaming provider (not counting sports content), and comparable to the sums spent by traditional television media companies like Time Warner and Walt Disney (NYSE: DIS).

Decreasing Returns

Netflix also spent more money on marketing in the second quarter. The returns disappointed.

U.S. marketing spending doubled year-over-year but user growth slowed. This suggests the U.S. market is becoming saturated, which makes foreign markets even more important—which is why investors liked the Sky deal. The problem, though, is that international markets are not profitable yet for Netflix, which makes domestic growth crucial.

Netflix will burn through at least $3 billion in free cash flow this year, after burning through $2 billion last year. I don’t see a way Netflix could stop spending mountains of cash for new content if it wishes to remain a leader, not with the likes of Amazon (NSDQ: AMZN) hot on its heels and other big boys—such as Apple (NSDQ: AAPL)—looking to enter into the TV on-demand arena.

What’s especially troubling is that Netflix does not have a particularly wide moat against competition. Its service is only as good as the content it can provide.

Even with the recent pullback, NFLX’s forward price-to-earnings (P/E) still hovers at an excessive 150. A high P/E doesn’t automatically mean a stock will fall, but to justify a high P/E, growth needs to be strong. This means if future subscriber data disappoints again, investors may rethink their Netflix growth assumptions and send the stock tumbling again.

The inside track…

The bulls argue that Netflix’s recent pullback is a buying opportunity, but don’t you believe it. NFLX remains too risky.

Other buying opportunities exist that don’t confer undue risk. The trick is learning when their breakouts are imminent. We can get you the inside scoop.

Relax; it’s all perfectly legit and above board. You see, there are secret Wall Street hotline calls that any everyday investor can call in to hear 100% legal inside information that will tip them off when stocks are about to move

Linda McDonough, chief investment strategist of Profit Catalyst Alert, is a seasoned veteran of hedge funds. Her “Rolodex” is priceless and she knows exactly when these under-the-radar calls will take place.

Linda sends alerts to her Profit Catalyst Alert subscribers telling them exactly which hotline numbers to call, the key information to listen for, the stock they should buy, and when to sell to take their profits.

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