On July 13th, 2011, Netflix (NASDAQ:NFLX) shares closed at $298.73. Three months later, the stock closed at $117.01. At the close of December 23rd, shares traded at $72.62. Before the stock price collapse, many analysts and writers, including myself, warned investors that a valuation north of $200 overvalued Netflix's growth and the stock was clearly a bubble. In addition, poor strategic decisions and lowered outlooks brought down share prices even more. In this article, I try to give a fair valuation to Netflix and give investors guidance on why the stock still appears overvalued.
The difficult part of valuing Netflix is that the company's strategic mistakes will potentially make it not profitable in 2012. Analysts expect an EPS of 15 cents in 2012, with lower estimates going into the red. This comes after an EPS of $4.10 (projected) in 2011, and $2.96 in 2012. Despite earnings dropping sharply in 2012, revenue is expected to increase to $3.62 billion from $3.19 billion. Netflix still has a lot of growth potential, but the company will struggle for the next few years. Projecting earnings forward WITHOUT considering next year's low earnings expectations, I value shares at $159.50. This number comes from projecting earnings trends through Q2 2011 forward four years using a 7.5 percent discount rate and 2 percent expected long-term earnings growth. I used such a low discount rate and conservative long-term growth rate based on current market valuations of other stocks. Since this valuation does not consider recent news of Netflix, this is a VERY bullish upper bound.
My bear valuation of Netflix came out to be $28.17. This assumes that Netflix's woes would continue for the distant future. This assumes an EPS of 65 cents in 2013, with modest improvement over the next few years. I used forecasting methods similar to those of my bull estimate, except with a long-term growth estimate of 3 percent instead of 2 percent to account for long-term recovery.
My estimated valuations suggest that Netflix stock has a 119.6 percent bullish upside and a 61.2 percent bearish downside. Since my bull valuation disregards all recent news of Netflix and my bear valuation accounts for it, I believe that Netflix shares are currently overvalued and my bear estimate is more relevant. There is a lot of risk that Netflix will never recover from next year's flat earnings expectations and it's still not worth the risk to invest in Netflix right now. Just because shares plummetted over 70 percent in 5 months does not mean that shares are now undervalued. Unless Netflix can right the ship and return to 2011-like earnings by 2013, I believe that the stock's price will continue to fall.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.