Go Long Netflix Stock, But Only as a Trade (NFLX)

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By now you know the market has been going crazy for Netflix (NFLX). What we are seeing is nothing more than a replay of the internet stocks of the late 1990s, when companies that made very little or no money would leap 40 or 50 points every day.

nflx netflix stockThere’s no question that Netflix has a great product, that it owns much of the streaming world, and that I have it in my very own home. There’s also no question that the company is making money, but not nearly enough to justify its truly insane valuation, or that it generates increasingly large amounts of negative free cash flow.

Look at its financials and cringe. For 2014, it made $266 million in net income. Not so bad, one might think. Yet add in the fact that free cash flow was negative $127 million and suddenly things don’t look so hot.

Then noticed that for the year-to-date, NFLX stock has only generated $50 million in net income and negative free cash flow of $392 million!

Then try not to pass out when you see NFLX stock trades at 193 times net income, and the market puts a value on it of … $53 billion.

My belief is that Netflix stock will never generate much net income or cash flow, because the studios know how much money it has and will always negotiate content license deals to keep the company on life support. It will always have to generate capital via equity and debt to keep making its own content.

How to Play Netflix Stock Without Getting Killed

And yet … Netflix stock is up almost 900% since the start of 2013. Is there any way at all to get involved on some of this upside? The answer is yes, provided you 1) recognize the risks, and 2) have an exit strategy.

NFLX is for traders. Before its 7-1 stock split, you could literally lose or make thousands of dollars a day with its crazy intraday moves. Now that it has split and is at $120, that volatility has been tamped down. You can trade with a lot less risk.

I believe Netflix stock is caught in the momentum stock trap, where it just gets bid up over and over again, and then it falls as traders grab profits. Then the cycle repeats, but the overall short-term trajectory is up. I think at worst it will land in a trading range, except when earnings are reported.

So I would decide how much you want to risk on Netflix stock and open the first of four positions — you’ll be allocating 25% of your total capital for each purchase. I would buy here at $120 or so, and add another 25% of your total on each $5 to $8 rise. That will scale you in slowly. Once you hit your capital limit, don’t put in any more money.

Then you must use stop losses. Again, you must decide how much you are willing to lose. If you are willing to lose $10 per share, then put a stop loss $10 below each buy point.

If you find yourself with increasing gains, and Netflix stock really goes nuts again, then do what I do — move your stop losses up. Should NFLX fall, you don’t want to give away all those profits. You want to preserve them by getting stopped out.

One final caveat: Netflix stock price tends to go insane after each earnings report — in either direction. You should consider selling out of your entire position before the report, because a stop loss becomes a market order if the stock opens below your stop loss the next morning. You’ll have blown right through your stop.

Alternatively, you could protect your position with puts, which will be expensive. If you feel like Netflix stock price could really take off in either direction, then sell out of your position, and buy puts or calls that are well out-of-the-money that will reduce cost but reduce upside.

Lawrence Meyers owns shares of NFLX.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/08/go-long-netflix-stock-trade/.

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