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Netflix: Can the Hyper-Growth Continue?

|Includes:Netflix, Inc. (NFLX), OUTR
Despite the positive market action this morning, investors in Netflix Inc. (NASDAQ:NFLX) are getting some cold water in the face.  The hyper-growth movie rental company announced a stellar second quarter last night featuring strong growth and upwardly revised guidance...  But this morning, shares are off roughly 10% as fanatical expectations are reconciling with the actual fundamentals.

Some key points from the earnings report:
  • EPS of $0.80 - up 48% over Q2 last year
  • Revenue of $519.8 mil - up 27% from Q2 last year
  • Gross Margin increased to 48.9% from 44.4%
  • Subscriber base of 15 million - up 7.4% just from last quarter
The guidance was fairly impressive as management increased their forecast for the year-end subscriber base to a range of 17.8 to 18.5 million (in April the estimate was 16.5 to 17.3 million).  But all of the impressive growth statistics weren't enough to satisfy the inflated expectations of momentum traders and storybook investors.

Keeping Up with the Expectations...


Hyper-growth stocks can be tremendous trading vehicles in a true bull market.  Typically, momentum traders trip over starry eyed buy-and-holders to propel growth stocks to incredible heights.  In this type of environment, the fundamentals really don't matter (short-term) as the price action becomes a feedback loop which continues to instill confidence and suck in new capital.

But in a more volatile and economically challenging environment like we have today, hyper-growth stocks can become dangerous minefields.  Expectations are more difficult to meet, and high price/earnings multiples cause mutual fund managers to "sell first, ask questions later."

In the case of Netflix this morning, pundits are pointing to the fact that subscriber acquisition costs rose by 2.1% - certainly not a pleasant statistic, but also not surprising considering the fact that NFLX has already picked the low-hanging fruit and now has to try harder to get each additional subscriber.

Regardless of the catalyst or fundamental reasoning, the bottom line is that the NFLX price action has turned decidedly negative - and is not likely to lift anytime soon...  With earnings expectations set at $2.65 per share this year, and $3.54 next year, there is room for multiple compression to send the stock down 30% and still have the stock priced for substantial growth.  If analyst expectations are revised lower, the stock decline could be substantially worse.



This morning, the stock is breaking through the key 50 EMA which has supported the trend since NFLX gapped higher in January.  Traders will hope for a bit of support at the most recent swing low near $103, but it wouldn't be surprising for that level to be broken - touching off all kinds of warning signals for traders with
any
technical inclination.

I'm currently sitting on my hands waiting for the situation to clear a bit before jumping in.  I'ts possible that the strength of the broad market could continue for a week or two - which would help NFLX investors to prop up the stock.  This could lead to an excellent entry point with a reasonable risk envelope and an open-ended shot at significant gains.

Coinstar Inc. (NASDAQ:CSTR)
is a good example of how hyper-growth names can quickly reverse course.  The stock made an incredible run this Spring, but after it's failed breakout in June, investors lost 30% in just over a months time...



As I mentioned in this week's View From the Turret, Coinstar investors should be carefully watching the NFLX announcement.  The broad consumer trends affect both stocks in a similar fashion, and both are vulnerable to multiple contraction.

I'm waiting for a convergence of market action, individual stock patterns, sentiment, and fundamental drivers before pouncing on either of these opportunities...  But they're both on the watch list and queued up for action when the time is right.

Keep those chips close to the vest,
MM


FD: No positions


Disclosure: No Positions
Stocks: NFLX, OUTR