The Netflix, Inc. (NFLX) stock price more than doubled in 2015, soaring 129% as international growth, a 7-for-1 stock split and faster-than-expected subscriber gains got investors lining up behind it.
That made NFLX far and away the best performer in the entire S&P 500 last year, with shares of runner-up Amazon.com, Inc. (AMZN) surging 119%.
While I think both stocks are a little frothy at current valuations, NFLX is in the most imminent danger of receding and shareholders should strongly consider taking some gains off the table — this year won’t be nearly as kind to Netflix investors as 2015 was.
In fact, Netflix shares are already getting off to a rough start: Baird Equity Research downgraded NFLX stock to “neutral” from “outperform” this morning, lowering its price target from $128 to $115 per share.
That was enough of a surprise to seriously ding shares in early trading as NFLX stock quickly shed more than 5% on the news.
Why 2016 Won’t Be Pretty
Based on a subscriber survey, Baird expects weaker-than-expected U.S. subscriber growth in Q4 2015, which would mark the second straight period of subpar domestic additions.
Baird also wisely noted that strong international growth — which is where the vast majority of Netflix’s market opportunity lies — is already largely priced into NFLX stock. The research firm also notes ever-higher content costs and stiffening competition as reasons behind its decision to downgrade.
I see all of these as valid concerns, but to me the most compelling reason to ditch NFLX stock is that it’s priced to perfection. I mean honestly, shares trade at more than 420 times projected 2016 earnings. That sort of blatantly euphoric multiple is unsustainable, and should be a red flag for investors.
The concept of a “return to the mean,” is also one I constantly try to keep in mind as an investor, and I think Netflix stock is on the wrong side of that trend. Dramatic short-term outperformance, the likes of which we’ve just seen with NFLX, will eventually be followed by dramatic short-term underperformance as the inevitable ebb-and-flow of markets has its way.
At the end of the day, stellar international growth will have to continue in 2016 for NFLX to have any chance of repeating its incredible 2015 performance. But as Baird noted, lofty expectations are already built into the stock price.
With sluggish data from China slamming the stock market on its first day of trading in 2016, the constant fight between “expectations” and “reality” is underway yet again, and reality is winning the first round.
That’s bad news for Netflix investors, who have all their money riding on expectations.
As of this writing, John Divine was long AMZN stock. You can follow him on Twitter at @divinebizkid or email him at editor@investorplace.com.
