Netflix: Exercise Caution After The Split

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About: Netflix, Inc. (NFLX), Includes: IMTM, IQLT, MTUM, QUAL
by: Brad Kenagy
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Summary

Netflix stock is set to split, so I created a simple two-part test to determine if a large-cap stock was worth holding after the split.

I found that those companies with quality and momentum characteristics significantly outperformed the market.

Netflix did not pass my two-part test and the underlying fundamentals support exercising caution after the split.

In this article, I construct a stock split investing strategy. With Netflix (NASDAQ:NFLX) announcing that they would conduct a 7-for-1 stock split, my interest in splits was piqued. I will give an overview of my stock split strategy and whether Netflix should be considered after its stock is split. The strategy I built consists of a simple two-part test to find quality large-cap stocks that have split.

I went to the Yahoo split calendar starting in January 2014 and went month by month looking for those companies that had at least a $10 billion market cap. I then took those companies and put them through my two-part test to find quality stocks with momentum characteristics that have split since the beginning.

Part 1: Quality

First, I took my list of stocks with a market cap of $10 billion+ that have split since the beginning of 2014 and I compared that list to the current holdings of the iShares MSCI USA Quality Factor ETF (BATS:QUAL) and the iShares MSCI International Developed Quality Factor ETF (NYSEARCA:IQLT). I found that the following nine companies were included in one of the two-quality factor ETFs. The reason why I choose to include Quality ETFs in my process was that each fund has exposure to large and mid-cap stocks "exhibiting positive fundamentals: high return on equity, stable year-over-year earnings growth and low financial leverage." [QUAL Description]

Split Date

Symbol

Company

1/9/2014

(NYSE:NVO)

Novo Nordisk

1/22/2014

(NYSE:MA)

MasterCard

2/27/2014

(OTCQX:RHHBY)

Roche

4/15/2014

(NYSE:UA)

Under Armor

6/9/2014

(NYSE:UNP)

Union Pacific

6/9/2014

(NASDAQ:AAPL)

Apple

6/26/2014

(NASDAQ:CELG)

Celgene

4/9/2015

(NASDAQ:SBUX)

Starbucks

6/12/2015

(NASDAQ:ROST)

Ross Stores


Part 2: Momentum

For my second test, I took the above list of nine stocks and looked to see if those stocks were in the holdings on the iShares MSCI USA Momentum Factor Index ETF (BATS:MTUM) or the iShares MSCI International Developed Momentum Factor ETF (NYSEARCA:IMTM). I found that three companies that split their stock in 2014 and both the companies that split their stocks in 2015 were included in one of the momentum ETFs and they are listed below.

1/9/2014

NVO

Novo Nordisk

4/15/2014

UA

Under Armor

6/9/2014

AAPL

Apple

4/9/2015

SBUX

Starbucks

6/12/2015

ROST

Ross Stores


Performance Review

For the three companies that split their stock in 2014, I looked at the total return of each stock in comparison to the total return of the S&P 500 (NYSEARCA:SPY) one year after the stock split. I found that each company outperformed the S&P 500 and the average total return was 37.96% compared to 12.84% for the S&P 500.

Split Date

Symbol

Company

Total Return 1 yr Later

SPY Total Return

1/9/2014

NVO

Novo Nordisk

14.98%

13.40%

4/15/2014

UA

Under Armor

60.55%

16.47%

6/9/2014

AAPL

Apple

38.36%

8.66%

Average

37.96%

12.84%


For the companies that split their stock so far in 2015 the results already look promising as well. The table below shows that Starbucks has significantly outperformed in the three months following its split and Ross Stores has outperformed the S&P 500 as well.

Split Date

Symbol

Company

Total Return 1 yr Later

SPY Total Return

4/9/2015

SBUX

Starbucks

12.75%

1.93%

6/12/2015

ROST

Ross Stores

3.67%

1.43%


What about Netflix?

I ran Netflix through my two-part test and Netflix did not pass because it was not included in QUAL and was surprisingly not included in MTUM as well. Personally, I consider Netflix a momentum stock; however, both MTUM and the PowerShares DWA Momentum Portfolio ETF (NASDAQ:PDP) do not include Netflix.

Looking at the quality ETF I can see why Netflix was not included because as I noted in the quality section above QUAL selects those companies with high ROE, stable earnings growth and low leverage. ROE for the most part has been in the 10-17% range over the last two years, however EPS growth has been less than stable and leverage has increased. Over the last three years, financial leverage has increased from 4.06 to 4.84 per Morningstar, which can be attributed to the increasing debt that Netflix has incurred due to content acquisition costs. The chart below shows that Netflix has had upward earnings growth over the last nine quarters, however, in the most recent quarter EPS fell significantly Q/Q, and fell Y/Y as well.

In addition, while cash flows are not part of the criteria for the QUAL I thought it was important to point out Netflix has gone from being cash flow positive to cash flow negative in the last few quarters. The chart below shows that cash flow has gone from slightly positive a year ago to significantly in the red this year and the trend is clearly to the downside.

Closing Thoughts

In closing, I believe investors should use caution for Netflix after the split because its earnings are volatile, leverage has increased because of increasing debt and free cash flows have been steadily declining. While I consider Netflix to be a momentum stock I do not consider it to be, a "quality" stock and I would not consider including it in my stock split strategy.

My strategy is simple, when a large-cap stock announces its going to split, you can look at the holdings of the quality factor ETFs and Momentum factor ETFs and see if that given stock is included in both.

Disclaimer: See here.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.