Netflix Doubters Abound, But Stock Still Surges. Why?

by: Benzinga

By Ronald Weisenstein

Shares of Netflix (NASDAQ:NFLX) are up another 5.42% at the close, as the company continues its incredible jump into the stock stratosphere. The stock has tripled in 2010, and the company's millions of subscribers have nothing but great things to say about Netflix services.

The company expects to finish this year with about 18 million subscribers, a huge jump from the 12 million at the end of 2009. J.P. Morgan projects Netflix could reach 29.5 million subscribers by the end of 2012.

Yet, Netflix short interest - shares purchased that will profit if the company's stock declines - has risen nearly 64% since June and now represents 28% of the company's float, according to FactSet Research.

"This stock is trading on faith," Wedbush Morgan analyst Edward Woo told the WSJ, acknowledging that his firm has been wrong so far on Netflix with its $78 price target and underperform rating. "The fundamentals come nowhere near justifying these prices."

What gives? Is the stock being artificially inflated by overly optimistic bulls? Or is the company's market valuation severely undervalued in relation to its earnings potential?

On the one hand, it's hard to justify a stock skyrocketing like Netflix has. The company has projected revenues of $2.15 billion this year, but $150+ for a stock that was below $60 in January is out of touch with reasonable valuations.

Sure, there are a number of subscribers, but the company is competing with the big dogs of media. The shift to online content streaming could destroy the future earnings potential of the service.

According to the Wall Street Journal report, "Such lofty expectations are being set as the company acknowledges that its core DVD-rental business, where it faces little competition, will eventually be replaced by its streaming video service, where it faces competition from the cable, satellite and telecommunications industries as well as Apple Inc. (NASDAQ:AAPL), Google Inc. (NASDAQ:GOOG) and Inc. (NASDAQ:AMZN)."

On the other hand, the company's market capitalization is only $8.7 billion. Netflix is consistently growing its subscriber base, and could transform the way Americans access their favorite TV shows and movies for years to come. Should management prove successful in holding customers, future cash flows surely justify the current stock price.

Credit Suisse recently said that 17% of Netflix subscribers use the service as a substitute for cable or satellite TV. That number could grow substantially, as more consumers seek cheaper content alternatives.

Buying into the Netflix story is expressing confidence that the company can continue to grow and satisfy its customer base. American consumers can be very fickle creatures, and consistently meeting expectations will be crucial. Should the company capitalize on long-term strategies, Netflix could eventually join the media giants.

Disclosure: No position