Investors should also keep in mind that while “insider trading” is illegal, what constitutes an illegal insider trade often isn’t clear, and insiders have access to information that may not be “material” from the perspective of the SEC but which may be material for practical purposes. Could these insider sellers have some information about the company that could negatively impact the share price? Absolutely!
While this may not mean that Netflix is going to stop growing or that it is going to lose money, keep in mind that the stock is priced for perfection. Any slip-up such as lower-than-expected sales growth or lower-than-expected margin growth could seriously hit the share price. Remember that the S&P 500 trades at 22-times earnings and that historically it has averaged about 14-times earnings, and even rapid-growth stocks in this environment are trading at 30-50 times earnings. It follows that we could easily see a substantial decline (50 percent – 80 percent) in Netflix shares if perception changes even if the company continues to grow rapidly.
Thus, if we consider the upside potential versus the downside risk you would have to believe that the stock can offer comparable upside. But under what circumstances can the stock trade at, say, 250-300 times earnings? We would have to see incredible growth and perhaps a game-changing development in the Netflix story. While this isn’t impossible, it seems pretty unlikely to me. With that being said, I think the Netflix trade is largely over at this point, and investors should follow the insiders’ lead and sell their shares.
Disclosure: Ben Kramer-Miller has no position in Netflix.