Like many Americans, I love Netflix (NASDAQ:NFLX). We have both the streaming and DVD services in my house, and there aren’t any complaints — we feel like we get our money’s worth, especially with the addition of House of Cards.
As for the stock, that’s a different story.
Netflix shares have become a casino game so far in 2013, which argues against either going long or short. Instead, the best bet now is to treat the stock as you would the content: Just sit back and watch the show.
Why You Can’t Buy Netflix
The case against Netflix is well-known. The stock is valued at 630 times trailing earnings and 66 times forward estimates, and is sitting at 13.3 times book. To put that in perspective, those metrics make Netflix the fifth-most richly valued company in terms of its P/E, and 32nd-highest in terms of its P/B, among all U.S. stocks with market caps above $5 billion. Margins are less than 1% at a time in which its content costs are rising, and growing competition makes Netflix the antithesis of the classic “deep moat” stock.
Despite this, NFLX shares are up 101% in 2013 — the largest gain of any company in the S&P 500 Index so far this year. When Netflix finally falls, it’s going to fall hard.
All of which means you should buy puts, right? Well, not necessarily …
Why You Can’t Bet Against Netflix
The problem with Netflix is there’s no valuation at which the stock can’t go higher. Like an Amazon (NASDAQ:AMZN) or a Facebook (NASDAQ:FB), the key drivers of the stock are the “story,” the potential and — most of all — momentum. Valuation doesn’t matter with these stocks, and it never has — so why would that change now? Just ask the analyst at JPMorgan, who raised his price target on NFLX from $180 to $205 just yesterday.
Another factor that continues to favor Netflix is that it’s delivering strong earnings growth at a time when the economy is stagnant, and investors are going to pay a premium for that. Top-line revenue rose 13% in 2012, and the company is expected to put up triple-digit EPS growth this year and next. Estimates for 2013 have jumped from 40 cents to $1.23 in the past 30 days, with 26 analysts raising and no analysts cutting. As long as investors are seeing these kinds of numbers, NFLX is going to trade at a ridiculous P/E — and value investors are just going to have to get used to it.
The stock also remains vulnerable to short squeezes. Although the total short interest has trended down from over 17 million shares in October to 9.7 million at the last count on Jan. 31, that still leaves a short interest of nearly 18% — plenty of fuel to keep this rally going far past the point where it would reasonably be expected to peter out.
Another issue with Netflix is that it’s so firmly in the grip of momentum traders that it has been moving with a nearly 1-to-1 correlation with the 10-year U.S. Treasury yield in the past week — indicating that the big money is using the stock as a proxy for high-beta market exposure. As long as this trend remains in place, nobody should try to fight it.
Leave This One to the Pros
History has shown that betting against Netflix on the basis of valuation alone or — worse — the mind-set that “It’s up so far, it can’t possibly go any higher!” is a recipe for losing money. The time when shorts really made money on this stock was in late 2011, but the catalyst was a headline — lower-than-expected subscriber growth and the Qwikster disaster — rather than valuation. With the earnings report just having occurred in late January, it’s not reasonable to hope that a similar miracle will happen again anytime soon.
The bottom line: Don’t buy into this insanity, but also don’t attempt to bet the other way. Netflix will be a great short some day, but current market conditions argue against taking that risk in the immediate future.
For now, there’s no shame in leaving this stock for the big boys.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.