As I told a colleague last recently, the move amounts to slicing up a pizza into 42 slices instead of six — which changes neither the total amount of pizza you have, nor the quality of that pizza.
The real question, then, is whether investors should order up a heaping helping of Netflix here or whether they should search for a tastier option.
Carl Icahn, for one, thinks there are better places to stash his cash. After NFLX hit another record high on Wednesday of last week, the activist investor tweeted that his firm had sold the last of its Netflix stake and instead was looking for opportunities elsewhere — including Apple Inc. (AAPL).
Even the greats can be wrong, though. And Icahn also recently went on record as saying he thinks the entire stock market is overheated, so perhaps his overall bearishness is coloring his judgement.
So what’s the score with Netflix? Should you cash out like Carl Icahn, or continue to ride this momentum darling?
Let’s look at the three biggest pros and three biggest cons for Netflix now:
3 Big Pros of NFLX Stock
Content Costs Under Control: As streaming video becomes the medium of choice for many consumers, content producers have been able to demand higher and higher royalties for their work — and as a result, some fear Netflix will see its margins squeezed. But history shows these fears are overblown. Consider that “costs of revenues,” which largely represent Netflix content costs, were $607 million in Q1 2013 under $780 million in total revenue. In Q1 2014, costs of revenue jumped to $762 million or about 26%, while total revenue was up about 36% to nearly $1.07 billion. Costs of revenue were up again in Q1 2015, rising 25% to $958 million, but the top line grew even faster with 31% expansion to $1.40 billion. In short, in two years of filings, we’ve seen revenue growth outpace the increased cost of content — meaning margins are looking good.
International Expansion is Impressive: A big focus of Netflix expansion has been on business overseas. And while the streaming video giant still doesn’t make a profit on its international operations, it is very close to breakeven. The division saw its total shortfall shrinking from $274 million in fiscal 2013 to under $160 million last year. Furthermore, revenue has exploded from $712 million in FY2013 to over $1.30 billion in FY2014 — an 82% growth rate! Investors are encouraged by the long-term potential here, and with good reason.
Plenty of Room for Growth: In 2014, Netflix raised prices by $1 per month, and while there was a brief blip in subscriber growth, the stock has continued to power higher and sign-ups for Netflix have continued at a brisk pace. Nobody likes higher prices, true, and there is undoubtedly room for increases here given past performance and the value that consumers find in the product. Furthermore, let’s not forget technological limitations still prevent some in America and millions elsewhere around the world from even considering streaming video thanks to unreliable access or the risk of running up expensive data charges. Technology continues to march forward and bring faster speeds more cheaply, and this will undoubtedly unlock bigger customer demand in the years ahead.
3 Big Cons of NFLX Stock
Big Investors Aren’t Buying Anymore: A mentioned, Carl Icahn has given up on Netflix. But it’s not just him alone, with Citigroup recently downgrading NFLX to neutral now that the stock is bumping up against the firm’s $722 price target. Similarly, Societe Generale noted the stock is “priced for perfection” and is plotting a $585 price target — a double-digit decline from these levels. Heck, even higher ups within Netflix itself are abandoning ship; seven insiders, including Netflix CEO Reed Hastings himself, have unloaded nearly 300,000 shares year-to-date worth over $200 million at current price levels.
Nosebleed Valuation: Sure, Netflix is growing nicely. But echoing the SocGen research note, NFLX stock is at the top end of valuations by any measure. The company trades for 5.9 times this year’s projected revenue and 4.7 times next year’s sales. Compare that with Amazon (AMZN), which trades for only about twice 2015 earnings, and only about 1.7 times next year’s sales. Looking beyond sales, Netflix has a simply staggering price-to-earnings ratio of about 500 based on 2015 forecasts and a forward P/E of about 200 based on next year’s profits. It’s hard to argue growth isn’t already priced in with valuations like these.
It’s Lonely at the Top: Netflix undeniably helped disrupt the entire TV industry, from inciting “cord cutting” to creating its own acclaimed programming like House of Cards and Orange is the New Black to feeding the phenomenon of “binge watching” on demand. But now that the success has been proven, everyone is trying to get in on this lucrative marketplace — whether it be HBO Go, Amazon with its Prime Instant Video or traditional broadcast networks with their Hulu joint venture. The pie is still growing and that’s great, but eventually competition will start to take its toll and Netflix may find itself not quite as secure as it once was.
Given the fact that there isn’t much margin for error, when things turn (as they always do for momentum stocks) it could be a long way down for NFLX stock.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not hold a position in any of the aforementioned securities.
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