by Charles Sizemore | October 23, 2013 9:11 am
Netflix (NFLX) stock soared early on Tuesday after Netflix earnings beat all expectations.
Net income more than quadrupled, while the NFLX subscriber base topped 40 million worldwide. Revenue rose 22% to $1.1 billion, and Netflix earnings per share of 52 cents beat analysts’ average estimate of 49 cents.
Netflix has grown to the point that it now the fifth biggest “network” in America, behind those of Disney (DIS), Comcast (CMCSA), CBS (CBS) and Twenty-First Century Fox (FOXA) — owners of ABC, NBC, CBS and Fox respectively. NFLX also has more domestic American viewers than HBO (though HBO has a larger user base when you include international viewers.)
Considering that Netflix has only been in existence since 1997 and that the hardware has only been widely available in the last five years, the NFLX growth is almost mind-blowing. Most of us now take for granted streaming content, a service that few Americans had ever heard of as recently as 2008.
But as impressive as the growth is, Netflix stock is not a buy at current prices … unless your time horizon is short and you planning on using a tight stop.
I wrote earlier this year that Netflix was leading a “new media revolution,” the biggest shake-up to media distribution since the introduction of paid cable TV. Netflix earnings in the most recent quarter practically make that case for me.
But the vanguards of a revolution are not always the ones who ultimately dominate the new regime that they create, and I expect this to be the case in the NFLX streaming revolution.
It is true that Netflix all but invented the content-over-Internet model, but its success has spurred competition from some very formidable and well-financed competitors. Amazon (AMZN), Apple (AAPL), Walmart’s (WMT) Vudu all offer high-quality streaming services.
And as I commented to InvestorPlace Editor Jeff Reeves, Amazon recently outbid Netflix for the streaming rights to three of the cartoon series that both my kids and Jeff’s kids enjoy watching: Dora the Explorer, Go Diego Go and Blue’s Clues. As the price of content rises due to this kind of competition — and as competition for subscribers keeps a lid on the fees that Netflix can charge its viewers — margins will inevitably get crimped.
A lot of the buzz surrounding NFLX centers on its original content, including the popular House of Cards and Orange is the New Black. These series have proven that an upstart like Netflix can produce quality content on par with the major networks.
As I said earlier this year about NFLX stock:
“House of Cards has been a boost to Netflix’s reputation in the same way that original programming vastly changed the way viewers thought about HBO and Showtime …
I don’t know anyone who buys HBO to watch movies; these days they buy it for its original programming — like the popular Game of Thrones. Netflix is trying to follow that model, and they are wise to. Otherwise, the company is a commodity seller of old content with nothing to distinguish it from its competitors.”
And all of that is great. But there is nothing to prevent Amazon and Apple from doing the same. There are no “moats” in place that cement the current NFLX position.
And given this, it’s hard to justify a forward P/E multiple close to 100 for Netflix stock.
Interestingly, investors may finally be realizing this. After opening about 10% higher today on the earnings news, shares of NFLX stock slumped to finish more than 9% in the red.
If you don’t own Netflix stock already, don’t buy it now. It’s too late.
And if you do own NFLX, consider selling it … or at least keeping a tight stop loss in place.
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he had no position in any security mentioned. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar but also which stocks will deliver the highest returns. The series starts November 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.
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