Why, why, why didn’t I buy Netflix (NFLX) when it sold off back in 2011? Netflix stock dropped from more than $300 per share down to barely $50 … before rocketing to more than $700.
I’d used the service for years. In fact, Netflix was the reason I bought my first streaming-enabled Blu-ray player back in 2009. I obviously saw the potential. Yet I let this one get away from me.
Sure, I’ll get the chance to buy it at around $100 … but only because Netflix just announced a 7-for-1 stock split.
NFLX is a true game changer. The company has changed the way we view and expect to view media content. The term “binge watching” didn’t really exist pre-Netflix. Now, watching an entire season’s worth of shows in a single weekend is considered normal.
Cable companies are tripping over themselves to make their interface look and feel more like Netflix, with Dish Network’s (DISH) Sling TV being the best example to date. And after conquering America, Netflix is now revolutionizing media overseas as well.
Can anything slow down the NFLX juggernaut? Maybe. Here are three possible speedbumps that holders of Netflix stock should watch out for.
Netflix Stock Risks: Valuation
Valuation doesn’t matter with a momentum stock … at least, not until it does. It’s fine for a fast-growing company to sport a rich multiple if it can realistically expect to grow into it. But are the valuations in Netflix stock realistic at today’s prices? Let’s take a look.
NFLX trades for 7 times sales and more than 200 times next year’s expected earnings. To put that in perspective, leading media companies like Time Warner (TWX), the owner of HBO; CBS (CBS), the owner of Showtime; and Amazon (AMZN), which has a streaming service that directly competes with NFLX all trade at significantly lower multiples.
To be fair, none of these companies is an exact apples-to-apples comparison to Netflix. But the valuation gap — particularly with a stock like Amazon, which itself trades at a premium multiple — is striking.
Given its rate of expansion, NFLX deserves a premium valuation. Is 7 times sales too rich? Probably. That’s a hard multiple to justify for a company with a $40 billion market cap.
Smart Money Is Heading for the Door
Carl Icahn, who was the ninth-largest holder of Netflix stock as recently as March, recently announced that he had dumped his large stake in the company.
Now, we should keep in mind that Icahn made an estimated six-and-a-half times his money in Netflix stock, so he might simply be taking (massive) profits. But it’s worth noting that NFLX insiders have been steady sellers of the stock for months. Seven insiders, including CEO Reed Hastings, have sold a combined 294,000 shares in 2015 worth nearly $200 million at current prices.
Now, it’s not unusual for the founders of a company to diversify once they’ve made it big, so we should take the insider selling with a grain of salt. But it is interesting that there has been no reported insider buying at all — by anyone — since 2012.
Competition Heating Up for NFLX
And finally, we get to competition. NFLX might have changed the media world forever, but its competitors haven’t exactly been sitting on their hands. Amazon has been competing aggressively on price, bundling its streaming service with premium delivery options for its regular online store. And Netflix, Amazon (and everyone else, for that matter) competitively bid for exclusive rights to content.
My concern has been that rising content costs would erode margins, though thus far that hasn’t been the case. NFLX’s margins have actually been expanding for more than two years now.
So long as Netflix continues to grow its subscriber base, it can afford to pay more for content. Someday, the music will stop, subscriber growth will fail to keep pace with content costs, and there will be a day of reckoning in Netflix stock. But that day could be years away.
Netflix has kept its service very competitively priced for years now, and subscriptions currently start at $7.99 per month. Subscribers haven’t reacted well when Netflix has tried to raise prices in the past, but Netflix is attempting to build loyalty (and justify future price hikes) with original content like House of Cards and Orange is the New Black.
Netflix is looking to emulate HBO, which is a smart move. But as I noted earlier, HBO’s parent company trades for less than half NFLX’s valuation.
Bottom line: Netflix is one of the most exciting growth stories of the past 20 years. But Netflix stock is also very expensive, and the easy money was made a long time ago. Buy it; trade it; have fun. But be prepared to sell when the bubble finally bursts.
Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.