After a precipitous decline, shares of Netflix (NASDAQ:NFLX) have been on the mend. Will the rally in Netflix stock continue or is it bound to unravel and revisit the lows?
To get a good sense of the answer, investors have to know their timeframe. Are they short-term traders looking to scalp a few points out of NFLX stock or are they long-term investors measuring time in years rather than weeks or months?
Breaking Down Netflix Stock
Analysts now expect $15.85 billion in sales this year. While that’s a whopping 35.6% increase from the same quarter a year ago, Netflix expects to spend about $8 billion on content this year. That’s more than 50% of revenue!
What a tremendous cost, although not something that investors seem to mind. As long as revenue continues to pour in and subscribers continue to come in ahead of expectations, no one seems to mind paying up for NFLX stock.
The “why” behind that thesis is pretty simple. Consider that Netflix has more than 130 million global subscribers and it’s easy to see what direction the content market is heading in. HBO, now an AT&T (NYSE:T) property, Netflix, Disney (NYSE:DIS), CBS (NYSE:CBS) and a number of others realize streaming is the future.
It’s like what Amazon (NASDAQ:AMZN) CEO Jeff Bezos said about innovation. He asked, not what will change in the future, but what won’t change. Predicting change is hard, be it based on timing, market adoption or a number of other factors. Predicting non-change isn’t as hard.
Paraphrasing Bezos’ explanation, no one is going to say, “I want to pay more for my products” or “I want the shipping to be slower and less efficient.”
It just doesn’t work that way and Netflix is a prime example (no pun intended). No one will say, “I want to pay $100 or more a month for a majority of channels I won’t use.” Particularly when we can get plenty of content we don’t want for just $10 a month. Jokes aside, it’s clear Netflix has foreseeable staying power.
Valuing Netflix Stock Price
Like Amazon though, how do we value Netflix stock, particularly after such a big rally? Analysts expect earnings of $2.69 per share this year, more than double the $1.25 a share it earned in 2017. In 2019, analysts expect another 70% growth to $4.38 a share. That leaves NFLX stock trading at 137 times this year’s earnings and at about 84 times next year’s earnings.
That’s obviously not cheap. But 84 times isn’t the most ridiculous number we’ve ever seen. Like Bezos though, what’s CEO Reed Hastings supposed to do? Stop investing so heavily in original content? Stop licensing content that resonates with viewers?
The truth is, Netflix needs to pour resources into its content budget to make Netflix as sticky as possible for the long term. Amazon poured money into segments and is now worth $1 trillion. I’m not saying Netflix is on its way to that valuation, but it’s clear what they need to do to earn and keep customers.
Is that completely priced in with its $160 billion market cap? Probably not. But it’s hard to say what its full potential is and when it will realize it.
Right now, the predominant factor is user growth. Not earnings, not revenue growth and not free-cash flow. Last quarter, the added 670,000 domestic subscribers was well short of the 1.2 million analysts were looking for, while international subs of 4.47 million missed estimates for five million new subscribers.
For those that will argue that analysts were overzealous, Netflix missed its internal estimates by a wide margin too (which were mostly in-line with consensus expectations).
Looking to Q3, management expected 5 million new total subs vs. expectations of more than 5.9 million subs.
Trading NFLX Stock
Another miss likely takes all the air out of Netflix stock price. As of now though, investors seem willing to give Netflix a pass. In fact, shares on suddenly on the verge of breaking out.
With a short-term uptrend, we can see that NFLX stock has been putting in a series of higher lows. Resistance (blue box) is floating between $370 and $377.
Aggressive investors can buy on a close over $370, while conservative investors may want to buy on a close over that $377 mark. The first immediate target would be a gap fill into the low $390s.
From there, $400 would be in the cards, then the $420 all-time highs. The setup is negated on a close below uptrend support.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell is long T.
