Netflix (NFLX) is a compelling story, not only because the stock price has appreciated over 200% in the last year, but because its technology is extremely relevant in today's society and will continue to be so for the foreseeable future. This is one of the cocktail party stocks of the past 12 months and rightfully so. Just last week the stock was trading at $210/share, then Credit Suisse placed a $280 price target on it and the stock mushroomed to $240 in only five trading days.
Unless you live in a high-tech hub like Silicon Valley or are an avid investor, the average person probably associates Netflix with the 20th century business model of mail order subscriptions. This is no longer the case. A few years ago the company started streaming its video service over the Internet and business is booming. Warren Buffett says to wait for a fat pitch when selecting a stock and Netflix appears to be way out of my wheelhouse with a P/E Ratio of 55 based on average 2011 earnings on Yahoo Finance. However, I obtained a copy of last week's Credit Suisse analyst report and want to take a close look at it in case I'm missing something here.
At first glance, it's easy to see that Credit Suisse sets the bar very high when assessing the value of Netflix going forward. The earnings per share estimate for 2011 is $5.16 and boldly moves to $8.35 for 2012. Yahoo Finance pegs the EPS average at $4.39 for this year and $6.29 for 2012 based on the 31 analysts that cover the stock. That's quite a difference in outlook. In fact, out of those 31 analysts, only 11 have a buy or strong buy rating on Netflix. The remainder breaks down as 13 hold, 5 underperform and 2 sell.
I've got to tell you flat out that this stock is too hot to handle and is probably a crowded trade - at least for this week. Only professional traders should own it. Credit Suisse may very well be right that Netflix can move higher because it is one of the most radioactive stocks on the market. It currently ranks seventh on the Investor's Business Daily top 50 stocks for the week and with the market gaining momentum, it can probably probe the upside because stocks on the IBD 50 are conducive to higher prices in the short term. That said, I really believe that the analysts from Credit Suisse who wrote the report did a disservice to their investors by not doing a thorough job. They wrote a puff piece. I don't know what kind of skull session they had when coming up with their numbers, but in my opinion, it was a pretty vacant decision.
The Credit Suisse analysts paint rosy scenarios about international expansion when concocting their earnings and revenue extrapolations. Much of this stems from the fact that Netflix introduced the streaming service to Canada in 2010 and has had a very successful campaign there. Subscriptions are projected to grow 20% a year through 2016 in The Great White North. However, this is a very small client base. The analysts contend that if, and the operative word is if, Netflix expands into one to two international markets per year for the next five years, then they will meet their numbers.
I can understand that the research department at Credit Suisse sees a bright future for Netflix because they compete, and I emphasize that word compete, in an area that will no doubt be in hyper-growth mode for the next few years. However, the Credit Suisse analysts were extremely cavalier when addressing the competition. They didn't seem too worried about it, like Netflix will be similar to Rommel going through North Africa or Sherman marching to Atlanta.
When Netflix chairman and founder Reed Hastings was asked in the last conference call: "Do you expect Google (GOOG), Amazon.com (AMZN) and/or Apple (AAPL) to be a more formidable competitor in 2011?", he replied: "Definitely, there are a lot of firms, including the ones you mentioned that could be a more direct competitor with us." Besides Facebook and Hulu.com, there are also large predators on the prowl: "Cable providers like Time Warner (TWC) and Comcast (CMCSK), direct broadcast satellite providers DIRECTV (DTV) and Echostar (SATS), and telecommunications providers such as AT&T (T) and Verizon (VZ)." That was courtesy of the Netflix 10-K. The hunter becomes the hunted.
One example of how the Credit Suisse analysts glossed over the hurdles Netflix will have to overcome goes back to international expansion, specifically in Europe. Their overzealous projections of potential subscriber growth overseas includes the countries Germany, United Kingdom and The Netherlands. The big problem here is that Amazon is already established in those countries with its subsidiary LOVEFiLM that they purchased earlier this year. Granted, they only have 1.5 million subscribers, but they have already established a beachhead there and with Amazon's deep pockets, can expand to other countries as well. Credit Suisse doesn't expect Netflix will enter the European market until 2013 at the earliest.
I believe in Reed Hastings and I tip my hat to him. He's created an incredible company with a very bright future ahead of it. Subscriptions are growing at a breakneck pace. However, a company and its stock are two entirely different animals. With a price at roughly $240 and its five-year CAGR of 30%, you get a PEG Ratio of 1.8 when you use a P/E Ratio of 55. Not too shabby if you are a momentum investor. But like I mentioned earlier, it's way out of my strike zone. I prefer PEG ratios at one, and even then, it gets a little dicey. The lower the better, especially if they are experiencing growth and its sector is out of favor. A good example are healthcare stocks right now.
Another thing to contemplate when deciding if you want to make an investment in Netflix is considering exactly what kind of a company they are. They are a facilitatior of digital media. A distribution company. Not a high-tech firm, although they use state-of-the-art technology to dispense their products. They have no significant moat around their business in regard to patents. In fact, their rival Amazon dispenses most of their content with their cloud based server farms.
Credit Suisse posted a disclaimer on the first page of their research report which read: "Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision." That I will do and you should too. Don't believe the hype.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Am short the market with inverse ETFs.