Netflix, Inc. (NASDAQ:NFLX) was the top-performing stock in the entire S&P 500 in 2015. So far in 2016, NFLX stock has severely lagged the market, falling 11.4%. In fact, after majorly disappointing earnings seasons the past two quarters, NFLX stock has more riding on its Q3 report than most other companies.
NFLX Stock Not a Bargain
NFLX stock is expensive based on almost every traditional valuation metric. Headed into Q3 earnings season, Netflix has absurd earnings ratios. Its price-to-earnings ratio is 317 and its forward P/E ratio is 117.
NFLX stock has never been a value play. But even when you factor in growth, its PEG ratio of 6.4 is also ridiculously high.
Sometimes growth investors prefer to look at free cash flow as opposed to earnings. Unfortunately, that’s also a problem for Netflix, which doesn’t currently generate positive free cash flow.
So how the heck was NFLX the best stock in the market last year?
Netflix is one of those story stocks that doesn’t trade on valuation. It trades instead on the story investors have in their heads about how great the company will eventually be somewhere down the line if they stick with it. In other words, the market is hoping the story has a happy ending.
For NFLX stock, a big part of that story is subscriber growth. Unfortunately, subscriber growth has been Netflix’s Achilles heel in 2016. In both Q1 and Q2, Netflix sold off by more than 10% when the company reported subscriber numbers that came up well short of the market’s expectations.
NFLX Stock De-FANGed
I’ve called NFLX a “story” stock. CNBC analyst Jim Cramer is a bit more blunt. Cramer has repeatedly called NFLX stock a “cult stock.” Cramer describes cult stocks as stocks that break “free from all traditional valuation restraints.”
However, if cult stock shareholders want their investments to continue to trade in the stratosphere, they better hope that the companies keep the Kool-Aid flowing. This year, Netflix has dropped the ball.
Cramer recently went as far as to boot NFLX stock from the group of large-cap tech growth giants known by the acronym FANG.
“I just can’t trust Netflix after two consecutive missed quarters until I see some acceleration in domestic sign-ups,” Cramer said in September.
In other words, it’s put up or shut up time for Netflix this quarter. If the company delivers a third disappointing subscriber number in a row, it will be even more difficult to find any reason to buy the stock at these prices.
A NFLX Stock Alternative
If Netflix finds a way to get back on track with subscriber growth at some point, the story could still have a happy ending. In the meantime, investors should consider other growth options.
Any of Netflix’s former FANG peers are solid large–cap growth plays. Facebook Inc (NASDAQ:FB) and Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) both trade at reasonable forward P/E ratios of under 26. Amazon.com, Inc. (NASDAQ:AMZN) remains a story stock from a valuation perspective. However, Amazon’s cloud services division has provided plenty of growth Kool-Aid in recent quarters to keep the share price afloat.
In addition, Cramer replaced Netflix in FANG with Alibaba Group Holding Ltd (NYSE:BABA). Despite its massive size, BABA has delivered incredible 33% and 49% year-over-year revenue growth in the past two quarters.
If you’re looking for value stocks to buy, there are plenty of them. If you’re looking for growth stories, BABA, FB, GOOGL and AMZN are all great ones. Until something changes, NFLX is neither a growth story nor a value. It’s simply an expensive stock.
As of this writing, Wayne Duggan was long BABA stock.
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