Vetr Blog

Crowdsourced price predictions for the stock market.

Netflix: Is the Show Just Getting Started?

It isn’t often that famed investor Carl Icahn admits a mistake, but that is exactly what he did while on CNBC last week. The subject of his mea culpa? Netflix ($NFLX), a company that has essentially done to the entertainment sector what Amazon ($AMZN) has done to the brick-and-mortar retailing business. Icahn took significant profits in $NFLX profits in late 2013 after the stock had risen sharply, against the advice of his son and co-manager Brett. Since then, the price is up another 20%, spiking sharply over just the past few weeks on strong subscriber growth, improved profitability, award-winning original content and big plans for international expansion.

As has been the case since $NFLX was founded in 1997, the company’s fortunes are essentially anchored to basic subscriber growth. Whenever growth in subscriber numbers have stumbled, the stock has gotten hammered; when it surges, the stock soars, even if there are concerning fundamental metrics like contribution margin slippage. Case in point: the company’s latest quarterly release beat expectations in terms of sub growth, sending investors into a tizzy and the stock roaring upward, but the numbers also showed declining per-sub profitability in the key streaming segment.

For any business predicated on ever-greater numbers of users, the percent of each dollar in subscription revenue that makes it to the bottom line is a key metric. Given the scale of Netflix, with 57 million customers worldwide, it’s not surprising that eventually, it becomes incrementally more expensive to attract new users. That’s not surprising. Yet overall, there should be increasing leverage in a subscription-based model, as fixed expenses are spread across greater numbers of revenue-generating customers, not the other way around. In this case, profitability seems to eroding among new streaming subscribers, Netflix’s most important segment (the DVD rental business is eventually going to disappear). Plus, the company announced plans to spend a tremendous amount of money to expand internationally, potentially a worrisome combination if the profitability of the users generated from that expansion is low.

Nonetheless, Wall Street, and investors in general, are enamored of $NFLX; of the 40 analysts covering the stock, 16 rate it a buy. However, another 20 rate it a sell, probably on valuation grounds; there is no doubt the stock is growing quickly and is extremely successful at what it does, but is it worth a forward Price-Earnings Ratio of 75 and nearly five times annual sales? users, as usual, are a bit more skeptical – of 26 active ratings, we have 14 bullish and 12 bearish, and the average 6-month price target of $460 is only 4.3% higher than the stock’s current quote. What do you think? Where will $NFLX be six months from now? Make a rating!