Netflix (NFLX) stock cratered Thursday after suffering a trifecta of bad news … but so what?
If you can’t hold on through the devastation, you really need to stick to index funds.
The valuation in Netflix has always been so absurdly high that it’s destined to rip lower on bad news. It’s a stock for traders and people who think they can see the future.
The only thing baked into NFLX stock is a fantasyland of unlimited subscriber growth and wee elves riding unicorns. The market never thinks to mark earnings multiples down for risks like, oh, say, slower U.S. subscriber growth, HBO coming to beat you down on your own turf or — oops — a profit warning.
So when all three of those things happened Wednesday, Netflix stock was destined to pull one of its familiar nosedives. After all, it has happened before, and as long as the market keeps giving NFLX impossibly high multiples, you can be sure it will happen again.
To recap: The biggest blow to NFLX stock week came from the disappointing U.S. subscriber growth it disclosed in third-quarter earnings. More than anything, Netflix stock trades on these numbers (with a multiple to suggest the U.S. has a population the size of China.)
Netflix was expecting to sign up 3.7 million global subscribers during the third quarter. Some Wall Street estimates were targeting closer to 4 million. So when U.S.-weakness caused NFLX to sign up only 3 million subscribers over that three-month period, of course traders pulled the plug.
The subscriber shortfall contributed to Netflix projecting fourth-quarter earnings well below Wall Street forecasts. That’s something that would hurt any company.
In this case, however, the timing couldn’t have been worse.
HBO Gunning for NFLX
It has been a long time coming, but Time Warner’s (TWX) HBO said Wednesday it will finally launch a standalone streaming service to compete head-to-head with Netflix. This is the most serious challenge to its business that NFLX has faced.
Netflix has more subscribers than HBO, and no one has a larger library of TV content. HBO, however, trumps NFLX in perhaps the most critical area: original content. Netflix is rapidly building up its own slate of shows, but had a long way to go before it can catch up to The Sopranos.
The HBO news might have spooked NFLX traders ahead of the release of poor third-quarter results, but neither that nor the subscriber growth nor the profit warnings were sufficient to cut 25% off a company worth $27 billion.
No, for that, you need an insanely overpriced stock.
Before the start of trading, NFLX stock was trading for 70 times forward earnings and 135 times trailing 12-month earnings. The growth forecast of 33% a year is no doubt torrid, but it’s hardly enough to justify such outsized price-to-earnings ratios. As long as Netflix trades at overstretched multiples, it will be susceptible to crashes.
Yes, bulls like to point out that Netflix stock has always climbed back from its crashes to reach even more dizzying highs. No one’s arguing that it hasn’t delivered outsized returns.
The problem with NFLX stock is that it is always primed to tank. And you never when that’s going to be.
All stocks carry risk, but when shares are as richly valued as Netflix stock is, they’re going to blow up periodically.
If that’s what you want in your portfolio, go for it, but it sure is a high-blood-pressure way to build wealth.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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