Recent Setbacks Just the Beginning for Netflix Stock

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NFLX stock - Recent Setbacks Just the Beginning for Netflix Stock

Source: Netflix

Netflix (NASDAQ:NFLX) stock has spent most of the summer in a trading range. The Los Gatos, California-based video-on-demand company has seen its stock enjoy some of the highest growth in American industry. However, that growth has taken NFLX stock to stratospheric levels. Investors should take a more cautious view as increased competition could slow company growth in the months and years to come.

NFLX Stock Is Range-Bound

The heyday of NFLX stock could be close to its end. I realize I have made similar predictions for almost a year and have come up wrong. However, company growth will run into headwinds that will make the NFLX stock price more difficult to justify.

From a chart perspective, NFLX stock appeared to form a double-top near the $420-per-share range. Since it last traded near that range on July 11, the stock has fallen by close to 18%. The drop began when the company reported on second-quarter earnings on July 16. Although earnings beat estimates, investors sold the stock off on a revenue miss. NFLX stock fell by almost 10% that day.

Steady moves downward followed. On July 30, NFLX fell by 5.7% as details of a Walmart (NYSE:WMT) streaming service came to light. The stock fell further and staged a comeback. It now has recovered most of the loss from the Walmart announcement but remains rangebound.

Specter of Disney Looms Over NFLX Stock

Netflix held its own against Hulu, HBO Now, which is now owned by AT&T (NYSE:T), and against the Prime streaming service from Amazon.com (NASDAQ:AMZN). I doubt Walmart will compete more effectively than these companies.

However, the company will soon face its most serious competitive threat to date. Once Disney (NYSE:DIS) launches its streaming service, much of Netflix’s best content and market share will leave with it. At $10.99 per month, I do not see customers dropping Netflix en masse. Still, they could decide to only subscribe to Netflix intermittently, perhaps when their favorite shows release new episodes. Such behavior would slow down growth.

Despite my negative sentiments, I love Netflix as a company. It has shown some of the consistently best strategic vision in the tech industry. This began when it pioneered the streaming concept that undermined the business model of the nation’s cable providers.

It continued by becoming the first streaming service to produce content. By this move, it built as much of a moat as a company like this can have. It will compete with the some of the world’s best-regarded content. Netflix planned $8 billion in content spending this year. This is more than Amazon or HBO combined. Also, at only $10.99 per month, few will cancel the service even if times were to become more challenging.

How Much Is NFLX Stock Really Worth?

Still, even with these accolades, a company generates only so much value. Analysts predict average annual growth for NFLX stock of 62.35% per year over the next five years. At a price-to-earnings (PE) ratio of 50 or below, I would encourage investors to buy. However, the current PE stands at over 150. On a forward basis, it still comes in above the 120 level.

The current price-to-earnings-to-growth (PEG) ratio stands at around 1. Even if we go with the long-term average PEG of 1.33 and the 62.35% growth rate, that takes the PE ratio to 83. Under those conditions, it becomes difficult to justify a 120 forward PE. Also, as I suggested earlier, maintaining that growth rate will become difficult when Disney’s content resides on a competing platform. I think Netflix the company can hold its own against Disney. However, NFLX stock will struggle to prosper to the degree it does today.

Bottom Line on NFLX Stock

Investors should take a more cautious approach to Netflix stock given the competitive threat that will come from Disney. NFLX stock has shown considerable resilience over the last few years as the company’s management keeps Netflix on top of its formidable competition. However, once Disney transitions from content provider to competitor, the company will struggle to maintain its current growth rates. As growth slows, the forward PE of 120 will become even more difficult to defend than it is today.

I see Netflix as one of the most innovative and best-run companies today. However, even with its strategic vision and near-flawless execution, I cannot justify buying NFLX stock at this price point.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

 


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