Have you ever really liked a company, used its products or services… but hated the stock? There is an old investment principle that goes, "invest in what you know." This might work if you know a product or service very well and you are ahead of the pack, capitalizing on the investment opportunity before others do. However, this doesn't always work, especially when you are discussing a company that has been around for several years, one that is already so well-known and praised by the majority of the investment community.
This is one of the problems I have with Netflix (NFLX). Right now, all I hear is good things about the stock and the company, that it is the greatest thing ever to happen to television and that the stock price will never go down. This is a major red flag and an opportunity to short the stock as the expectations for the company come back in line with reality.
I like Netflix as a service. The company has created original, high-quality shows like Orange is the New Black, and streams the show Breaking Bad, probably the best show on TV. However, when it comes to investing, I wouldn't Netflix stock with a 10-foot pole.
Netflix - What Does $345 a Share Buy You?
Netflix is the world's leading Internet television network with more than 37 million members in 40 countries. The company is currently valued at more than $20.6 billion.
I cannot stomach buying a company that is as ridiculously overvalued as Netflix currently is. Netflix currently trades at a 436 P/E. For 2014, 21 analysts covering the company have a target full-year EPS of $3.32, for an impressive year-over-year growth rate of 118 percent. Even if the company were to hit these targets, the stock would still have a forward P/E of 97.5.
If we take the story out a bit further, by 2016 analysts have projected a fairly aggressive EPS estimate of $7.65 a share. If Netflix were to hit these numbers, this would give the company a 3-year EPS growth rate of over 400 percent. Even if Netflix were to hit this target EPS of $7.65 by 2016, the company would still have a P/E ratio of 42.3, which is still fairly high, even for a growth stock.
My question to Netflix bulls is this - do you honestly believe this type of growth is sustainable over the long-term? I am not saying Netflix cannot hit these analysts targets; it is possible. However, at some point, you've got to believe that growth will slow, or an earnings will miss. Even if Netflix were to hit these analysts targets, I believe that at some point growth will slow considerably and shares will re-adjust in price.
Netflix P/S ratio is currently 5.04 and the company has a forward P/S ratio of 4.38. This is very high, compared to Amazon (AMZN) which has a P/S of 2.25.
The bottom line is investors are currently buying the story that Netflix will replace television as we know it. In my opinion, this seems like a very speculative bet with many risks.
Competition from Amazon
Another reason I'd be worried as a Netflix shareholder is increasing competition from Amazon Prime. Amazon has a market cap almost 10 times Netflix and can easily compete with Netflix in this space.
According to a Bloomberg report, Amazon is spending an estimated $10 million to $50 million on a show called "Betas," which "depicts a motley band of twenty-something Silicon Valley entrepreneurs coding around the clock to develop a social-media site to rival Facebook Inc."
Amazon has also even set up its own studios "Amazon Studios" to make its own content. The company is currently developing a web series called "Alpha House" starring John Goodman and Bill Murray.
Other competitors including Hulu, Now TV, and, of course, HBO.
While Netflix has great shows like Orange is the New Black and House of Cards, HBO still dominates with shows like Girls, Game of Thrones, Boardwalk Empire, Curb Your Enthusiasm, The Newsroom, Eastbound and Down, etc. For fans of these shows, there may be no reason to sign-up for Netflix.
Insiders are Selling
While insider buying and selling is not the only factor to consider when buying or selling shares, it is definitely something I want to take a look at. When multiple insiders are buying shares, I gain more confidence in my investment thesis, and vice-versa.
The insider selling at Netflix has been plentiful. According to E*Trade, the following insider sells have taken place over the past year:
- The CEO Reed Hastings sold 15,238 shares on September 24, for a market value of $4.6 million. It is worth noting, however, that Hastings still owns over 1 million shares of Netflix.
- Director Leslie Jean Kilgore sold 6,336 shares on September 10, 3,010 shares on September 23, and 2,945 shares on October 2.
- The Chief Financial Officer sold 6,336 shares, his entire position, on September 10.
- Tawni Cranz, an Officer, sold 1,188 shares on August 23.
- Timothy Haley, a director sold 18,576 shares on August 5.
*It is also worth noting that zero insider buys occurred over the past year.
If Netflix is the next big thing and if the stock price still has room to run... why are so many insiders selling? Perhaps even more worrisome is the fact that all this insider selling took place before today's quarterly earnings.
Why Are Shares Rising?
Netflix is a very speculative stock, in my opinion. It seems every time the stock rises 5 percent it is on news of a new streaming content deal or a partnership. It seems to me that investors are betting that Netflix is replacing modern television as we know it. Netflix is not the only game in town, however, and has a lot to prove.
The bottom line is this: "Markets can remain irrational a lot longer than you and I can remain solvent." So too has the stock price of Netflix. Over the long-term, however, the market always tells the truth. I believe shares of Netflix possess far more downside than upside at present levels, and could be due for a pullback in the future.