Netflix, Inc. (NFLX) is up about 80% year-to-date, in large part thanks to a blowout earnings report in April.
But NFLX stock isn’t done yet despite its big run, and the momentum in Netflix could continue across the summer months.
It’s partially about continued growth, including the 24% revenue jump last quarter on a strengthening international business. It’s also partially about the narrative of Netflix stock, with NFLX being the “first mover” in streaming and the go-to source for on-demand movies in many American households.
But most of all it’s about a strong history of profits — and the idea that a stock like Netflix tends to go higher simply because it goes higher.
Netflix Stock Can’t Quit
First, let’s talk broadly about the idea of momentum. There was a great post on the blog Dynamic Hedge recently, talking about the fact that momentum stocks like Netflix often see sustained run-ups after an initial pop … or on the flip side, sustained declines once the stock starts to fade.
To be clear, the blog was talking about momentum broadly and not NFLX stock in particular, but the lessons still apply.
Anyhow, here’s the basic take, direct from Dynamic Hedge:
“Markets trend. End of story. When news comes out on a stock, prices do not instantly reset to a new equilibrium price. Sometimes stocks gap on the news release but they often undershoot and continue to trend toward what eventually becomes a new fair value. Overshooting the equilibrium price also happens but is far more common in the most mature large market cap stocks and news after a prolonged run. …
“Investors underreact in part because they anchor themselves in past events that are already well understood. Once an idea has taken hold in the mind of an investor or analyst, it’s tough to detach the old view and fully appreciate the new view. Since we have such a hard time digesting new data, trending markets can partly be seen as the digestion of information.”
That’s a very simple but very shrewd take on how momentum works — and there is no more compelling display of that trend playing out right now than in Netflix stock.
Consider that, from April 6 to April 17, NFLX stock ran up 38% in anticipation and then validation of great earnings. But since then, Netflix stock is up another 10% in about six weeks while the market is flat.
There hasn’t really been any new news, per se, just the continued “digestion of information.”
Sure, there’s the typical talk about Hulu and Amazon.com (AMZN) with its competing Prime service. There’s also a kerfuffle about Netflix advertising and what it would mean to the service. There’s also plenty of continued commentary about amazing growth offset by sky-high valuation; yes Netflix earnings and revenue are moving higher, but a forward P/E of more than 180 based on 2016 earnings forecasts of $3.20 per share is staggering, and a forward price/sales of about 6.5 is pretty elevated.
But by and large, it’s the same as it ever was — and thus, Netflix stock keeps moving higher, just as it has in the past.
Bottom Line for Netflix Stock
Now, as the saying goes, the trend is your friend… until it isn’t. And Dynamic Hedge points to this risk, too, saying, “Sometimes trends turn into manias and markets overshoot on the upside. … On the downside, prices can be quick to reset but are equally slow and often stubborn to trend lower and then often cascade once momentum is achieved to the downside.”
So Netflix investors should always be wary that NFLX stock could roll over.
However, it’s interesting to note how quickly the bears abandoned Netflix stock ahead of earnings and drove short interest to the lowest levels in some time. So it appears that an inflection point isn’t quite yet upon us, and there’s more room to run.
So for now, it looks like my January call that Netflix would be one of the best stocks of 2015 has proven right!
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP.
