Netflix's Price Drop Is Precursor - These Companies Could Be Next

Includes: AMZN, GRPN, NFLX, P
by: Benjamin Goldman

After hours Monday, Netflix (NASDAQ:NFLX) lowered its earnings outlook far below analyst expectations and announced a loss of 800,000 subscribers, causing its price to drop over 27 percent in afterhours trading. Netflix as a company is financially sound and still has an excellent business model, but its foiled plan to split in two has crippled its chances of any substantial growth in the future. High growth companies like Netflix are very difficult investments because if their earnings flatten even one quarter before analysts expect, it can cripple the company's stock price and leave investors with tremendous losses. In this article, I analyze a few more stocks that risk becoming the next Netflix.

Pandora (NYSE:P) has been performing well over the past month, with its stock price increasing by about 40 percent. The internet radio itself has done a good job of staying user friendly and improving its appearance. However, there are plenty of formidable substitutes out there including Grooveshark, 8tracks, and What's difficult about internet radio is that there will always be competition and unlike search engines, it is a fairly easy industry to enter. Pandora's earnings have been dropping recently instead of increasing, and I fear that the company is one bad earnings report away from dropping fifty percent. Its business model is very similar to Netflix. The company redefined a value chain in an industry that has been struggling to remain profitable. When looking at how much Sirius has struggled over the years, it is hard to imagine that Pandora can ever post consistent positive earnings. Companies that try to generate revenues off of music sales tend to struggle. Even music selling giants like the Apple (NASDAQ:AAPL) iTunes Store still struggle to be profitable.

Amazon (NASDAQ:AMZN) has very high earnings expectations as its P/E ratio is over 100. The stock trades at a much high earnings multiple than competitors like eBay (EBAY, 23.5) and Wal-Mart (WMT, 12.8), and its $108 billion market cap towers over competitors' like's $250 million market cap. If its earnings growth flattens out even a little bit, its shares could experience a 60 percent haircut in a matter of months. However, I wouldn't be so quick to short Amazon. It is hard to predict how consumers will react to the Kindle Fire and there is definitely potential for Amazon to crush earnings expectations if consumers are looking for low cost alternatives to iPads, laptops, and other high end consumer electronics this holiday season. I would place a hold recommendation on Amazon for now and after its Q3 and Q4 earnings reports, it should be much easier to see where the company stands in the market.

Groupon's (NASDAQ:GRPN) IPO looks like it will value the company around $12 billion. Although I do not believe this is a disgustingly high valuation of the company, one still has to worry about the competition. With Living Social and Google Offers entering the market, it is hard to believe that any deals website can gain a long term competitive advantage. As a first mover, I can see Groupon going the way of AOL (NYSE:AOL) or Netscape very quickly and losing substantial value early.

Companies like Netflix, Pandora, Amazon, and Groupon are very hard to value because of their small physical footprints compared to more traditional business models in retail and distribution. Although they can produce flashy earnings and fetch high P/E ratios, investors have to be aware of these companies' potential to lose popularity and significant value overnight. For those who like to invest in innovative companies like these, I suggest being heavily diversified or investing in more developed companies in the space with a proven track record and lower earnings multiples.

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