Netflix: Buy, Sell, Or Hold?

May.25.12 | About: Netflix, Inc. (NFLX)

Netflix (NASDAQ:NFLX) offers consumers instant online streaming video and DVDs. A big issue for Netflix has been the increased price of its DVD rental package. Many customers dropped Netflix following this change. But I see this drop as an advantage for Netflix now and in the future, as this drop caused Netflix to concentrate more on its online streaming and the amount of content it has available online. In the future, I believe that people will be looking for even more convenience. I firmly believe that increasing the amount of videos available will increase the company's revenue.

There is pressure from competitors such as Coinstar's (NASDAQ:CSTR) Redbox, which offers $1 video rentals, and Amazon (NASDAQ:AMZN), which offers online video streaming. These two companies are putting immense pressure on Netflix, and will continue to do so in the future. Between these two companies, Netflix must be cautious of how its revenue and cash flows will be affected in the future. There are a few avenues Netflix could take to lessen this competitive pressure.

Over 90% of customers only use Netflix's online streaming, and because of this, CEO Reed Hastings went ahead and raised online streaming prices. This, in my opinion, was a smart move, as Hastings was acting in the best interest of shareholders at the time. While I think this was a great choice, I also think changes like this should be implemented more slowly.

Taking into account my own experiences with other video rental companies like Hulu, Netflix needs to make customers feel more secure in their purchases from Netflix. Hulu, for example, offers free weekly videos and a free trial of its "Hulu Plus." With just a few minor tweaks such as these, Netflix could boost subscriber confidence, and increase revenue and cash flows in the future.

One thing that Netflix is currently doing that will help boost its number of subscribers is making contracts with other companies such as Weinstein Company. With deals like this, customers will have more choice on content. With new content, margins will expand, as customers will be more willing to pay for Netflix.

The problem now is that Netflix may need to increase it prices again in order to offer more streaming content. However, the company is hesitant due to the aftermath of the latest price increases, which caused many subscribers to discontinue their subscriptions. This will ultimately create an increase in the cost of goods sold, but would also increase the company's net income. So, where does the company go from here? If Netflix can generate enough money to put toward increasing its video selection, it should be able to keep up with competitors like Redbox and Amazon.

Another way to look at Netflix is through intrinsic price valuation. To calculate this, I used the price-to-book valuation. Based on my calculations, this intrinsic price is $16. This intrinsic price can be compared with what the market price is currently, which is $69. What this means is that Netflix is highly overpriced at the moment.

Another option for Netflix is to team up with one of the major cable companies. If Netflix could work out a deal with Dish Network (NASDAQ:DISH) it would be able to position itself better against movie channels like HBO. Additionally, customers would be able to pay their Netflix bill directly through their cable bill. In this light, I think customers would be more willing to pay for Netflix if they did not have a separate bill to pay for cable and Netflix. This would be another way for Netflix to boost its bottom line.

The next several years are critical for Netflix. The company will likely continue down a bumpy path. I am confident that its stock will see gains, as long as Netflix keeps a close eye on its revenue and content offerings. If you plan on holding onto your Netflix investment for five years or more I think it will pay off. However, if you are looking to hold for one year or less, I would recommend selling the stock now. In the future, companies such as Redbox and Hulu will likely continue to increase their sales putting even greater pressure on Netflix. Yet, I do not see this lasting forever. Netflix is going to do whatever it can to be on top again. CEO Reed Hastings was looking toward the future of the company by increasing prices to increase the number of streamed videos. Just as quickly as customers fled, many could eventually make there way back to Netflix.

As they say, patience is a virtue for those investing in Netflix. It really comes down to how long you are willing to hold on to your stock in order to realize a reasonable return.

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