Netflix: Blind Faith in the Story Can Get You Killed

Jul. 5.11 | About: Netflix, Inc. (NFLX)

In the mid-1980s, Bruce Springsteen closed his introduction to the E Street Band's cover of War, noting: Blind faith in your leaders, or in anything, will get you killed. Given the fact that another Springsteen anti-war anthem, Born in the U.S.A., was inappropriately used over the weekend at Independence Day celebrations, that famous quote holds even more apropos today.

Given Netflix's (NASDAQ:NFLX) bullish reply to my latest bearish article (the two events are not related), several points require some clarity. The theme that underlies what follows is quite straightforward: Storytellers spin stories. And blind faith in the story, as a bull or bear, can get you killed.

Given how NFLX continues to power higher I should probably just take my own advice, ignore the writing on the wall and go long on the basis of the story. After all, the weight I give to the story makes me a momentum investor; NFLX - newsflash - is a momentum stock. I just cannot bring myself to do something that I consider disingenuous, if not just flat out dishonest.

Blind faith in the bearish take on NFLX, quite obviously, can get you killed. If you're a smart investor, however, who just could not bring yourself to go long, you've spared yourself. I know I have. Many of my articles that include a pessimistic play on NFLX include a warning to practice risk management, particularly through the use of stops and the notion that it's better to take small losses, avoid devastating ones and live to fight another day.

When "another day" finally comes, it's the blind faith of NFLX bulls that could get them killed. Hopefully, most NFLX bulls have riden the momentum and will get out with massive profits when the stock comes crashing down like a drunk on a barroom floor. I fear, however, that the many people I see buying 100 shares at 283.79 are not merely adding to an already wildly profitable position, but, instead, are getting in at the top.

The Netflix story is one I cannot bring myself to believe. My articles have highlighted the rising content costs, all-too-rosy international outlook and a conference call format that guards against tough questions getting aired, let alone answered. And the story, even if its simply coincidence, keeps getting spun in such a way that reality takes a backseat to the euphoria momentum can bring.

Interestingly, one of the few stories to see the light of day on Netflix's downward guidance for Q2 hit the wire on the Friday evening prior to a long holiday weekend. it was followed up by the news this morning that Netflix will expand to 43 countries in the Caribbean and Latin America. As usual, Wall Street and potential Main Street bagholders digest the news superficially, filtering out anything that does not fit in with the Netflix story they want to believe.

Consider two pieces of information that investors effectively ignored as they drove the stock to its all-time high of $285.69 $288.00 $288.85 $289.00 $291.23 on Tuesday morning.

  • From the above-referenced MarketWatch story: Mark Mahaney, who covers Netflix for Citigroup, said in a research note that the new launch “is bigger (and) broader than the market was expecting,” even though there is “absolutely no guarantee that Netflix will succeed in any of these new international markets. Review the international story Netflix tells and ask yourself, is it possible that things will play out as the company says?
  • From a Dow Jones Newswire note this morning: While Netflix (NFLX) has hit a record high of $283.50 on word of plans to expand its online movie rental service to 43 countries, not everyone is applauding. S&P equity group says investors should be selling the stock. While the expansion offers a "substantial" growth opportunity in the long term, profit margins will be sacrificed in the near term, firm says. Also, "competitive pressures in NFLX's core market remain a concern," and shares are overvalued, S&P feels. Investors aren't too worried in the immediate term ...

The story cuts both ways. If you're not careful blind faith in the version of it that you subscribe to can get you killed. I've been taken to task for being "wrong" about Netfix. And then further chided for questioning conceptions of the words "right" and "wrong," as used in trading and investing.

It's not so clear cut. Technically, I have been "wrong" on NFLX, the stock, but does it matter if I am ultimately "right" on NFLX the company? If you took what I wrote and used it as the impetus for making a bearish bet on NFLX, you may have lost money. But, if you understand the idea that, as a trader and as an investor, you will probably be wrong more often than you will be right and you do the things necessary to still come out on top (manage risk, use stops, not only take but embrace small losses, etc.), a loss on NFLX should mean very little to you. If it does, you probably should stay away from such a volatile game.

This story has yet to objectively play itself out. It will, however, over the next several quarters tell itself, irrespective of bullish or bearish spin and how Netflix constructs its earnings conferences calls and reports or does not report balance sheet- and subscriber-related numbers.

The pre-earnings bear put spread (buy NFLX Aug $250 put/sell NFLX Aug $220 put) I suggested over the weekend just got roughly $250 cheaper to put on thanks to today's surge. If you see it as an opportunity, by all means, wait for things to settle down and go for it, but do not be a passive investor. Contrary to what a few commenters to my NFLX articles posit, you have control over your destiny here. If the momentum continues, stop yourself out, taking a loss you can afford, relative to your account size and need for the money.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.