Netflix Returns To Predictability

| About: Netflix, Inc. (NFLX)
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We all are creatures of habit. Whether we put the right shoe on first everyday, or we sleep on the same side of the bed, we all can be predictable in the long run. Sometimes, we find stocks that fit this pattern. As I've detailed throughout the past year or so, Netflix (NASDAQ:NFLX) is one of the best examples of a predictable stock.

The pattern is simple for Netflix. The stock drops, either on bad earnings, a new competitor, or some other negative news. After it hits a low point, we get some small piece of news that usually is insignificant. That pushes the stock up a little, and because this stock is so heavily shorted, the stock runs up 20%, 30%, or more before you even blink.

Well, Netflix has done this again. Unfortunately, I didn't make any money off this latest run, despite the fact that I called for this rally earlier this week. Just read the following excerpt from a stock preview I had published earlier this week:

But we've also seen a number of Netflix pre-earnings rallies in the past (unfortunately, they've lead to collapses after earnings). Some of the rallies were just pure short covering, and other times we've seen news come directly from the company. Would anyone be surprised if the company, or CEO Reed Hastings, came out bragging about September hours viewed, or something like that? News like that has pushed up shares at least $10 in recent times, so if something like that happened, it would not shock me to see shares back at $65 within two weeks.

My general point was that any small piece of news could get this stock going rather quickly, and that's exactly what happened. Netflix stock is up $12.23 in four days this week so far, a gain of 22.5%. I thought Netflix could be back above $65 in less than two weeks. Well, it just took a couple of days. Here's why.

First, on Monday, we got various stock picks out of the annual Value Investing Congress, an event where big name money managers and the like network and give stock picks. It was at this event last year where hedge fund titan David Einhorn presented his short case against Green Mountain Coffee Roasters (NASDAQ:GMCR). Green Mountain shares are down about 75% since then.

It was at the event this year that Whitney Tilson of T2 Partners basically doubled down on Netflix, calling the company a real global growth opportunity. When Tilson speaks on Netflix, investors tend to listen, and that has sparked shares in both directions in the past.

The rally continued on Wednesday as Citi called Netflix a screaming buy. The firm believes that customer satisfaction has improved since last year's debacle, and that helps with customer churn. The firm also believes that Netflix is trading at a very reasonable valuation, based on the estimate that Netflix will generate $5.50 in US earnings per share in 2013. At a 10X multiple, the firm believes you are getting a free call option on Netflix's international business.

On Thursday, Netflix announced that its original series, House of Cards, will be exclusively available to Netflix subscribers in February 2013. Those that believe in Netflix's future believe that Netflix producing its own content can be extremely beneficial, more so than just purchasing content from other providers. All 13 episodes of the first season will be available on Feb. 1, and Netflix expects to start shooting the second season sometime during the spring.

But the problem for Netflix is that while a larger investor making a bigger bet on the name, plus a positive analyst call are nice, they still don't change the fundamental problem with Netflix. That is, that competition increases almost weekly, and Netflix will be squeezed in terms of revenues, margins, and content.

This week's addition to the competition was Toys 'R' US (TOYS), which announced it would enter the digital content space. The company will launch a new website this week that will contain over 4,000 movies and TV shows. Movies start at $2.99 for a 24-hour rental and $5.99 for digital download or streaming. Television shows begin at 99 cents, with most priced at $1.99. The service will be powered by Rovi Corp (NASDAQ:ROVI), and the world's largest toy company will look to expand this service further to more devices down the road. Don't forget, Toys 'R' US is launching its own $149.99 tablet, which will go on sale October 21st.

Netflix may just shake this off and say that the content pool for Toys 'R' US is small, and it is when compared to Netflix. However, this is another example of individual content available, kind of like what you can do on Amazon (NASDAQ:AMZN). The ability to just rent or buy one movie, or one television show, is a very interesting proposition and one that Netflix cannot ignore. I personally don't use Netflix because I just don't have the time to watch enough to make the monthly subscription worthwhile. But if I miss an episode of a favorite show, I can go right to Amazon and buy it for a couple of bucks. I did that recently, and will continue to do it in the future.

But the overall problem is that even though there isn't one particular Netflix killer out there, a new smaller competitor seems to form each week. In addition to Toys 'R' US and Amazon, you have BSkyB in the UK, you've got the Coinstar (NASDAQ:CSTR) and Verizon (NYSE:VZ) partnership launching soon, Hulu Plus, etc. While no one competitor can match the content library Netflix has, they do push up the prices for content, which both hurts Netflix's margins in the long run, and pushes Netflix to dump some deals. Netflix already dumped Starz, lost Epix exclusivity, and just recently lost content from A&E and the History Channel.

Altogether, the latest move by Netflix was predictable. One small analyst note and a big investor pushed the stock up 22.5% in four days. These are the kind of moves that make long-term investors cringe, and they are likely to continue for Netflix. In fact, I wouldn't be surprised if shares dropped back down to those 52-week lows once again and rallied back to $65, even before Netflix earnings on October 23rd. Netflix hasn't fared well after most of its recent earnings reports, so I would not be surprised if we see a rally into earnings and then another fall.

With analysts currently forecasting $0.91 in earnings for 2013, Netflix is currently trading at more than 73 times forward earnings. In my opinion, that makes Netflix a short on valuation. Netflix will drop again, and it will rally again, and that's why the company has returned to predictability. But in the long run, the company must fend off too much growing competition, and I don't think that bodes well for Netflix.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in NFLX over 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.