Netflix: Should You Jump Aboard?

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On Monday afternoon, shares of Netflix (NASDAQ:NFLX) spiked nearly 7 percent after the world’s leading online content streaming company announced that its earnings per share topped estimates and after announcing that it would raise prices on new subscribers.

Netflix has been a controversial stock for years. On one hand, the company is the leader in offering low-cost online streaming content to customers worldwide. It also has had success with hit TV shows like House of Cards. The company has been growing its sales and its subscriber base at a rapid pace, and many investors remain optimistic that the company will continue to grow subscribers who wind up being regular customers for an extended period of time.

The trouble is that this growth and market leadership comes at a very high price — the company is valued at about $22 billion. Meanwhile, its annual revenues equate to about $4 billion, and very little of this makes it to the bottom line. In fact, the company’s trailing earnings come in at less than $3 per share, ,which means that at $372 per share, the company trades at 124 times earnings!

Furthermore, despite this incredible valuation, Netflix faces a lot of competition from companies such as Hulu and less directly from Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG), and Comcast (NASDAQ:CMCSA). Despite the company’s world-renowned service and its virtually universal brand recognition, these competitors are huge companies that are extremely well capitalized.

So far the bulls have been right, and the numbers that came out on Monday speak to this. Not only did the company grow its revenues by 36 percent year over year, but it grew its subscriber base by a whopping 4 million subscriptions in just the last three months, bringing the total number up to 48 million. For this reason, the stock is up 7 percent after hours, and it is up over 1,000 percent in the past 10 years, making it one of the best-performing stocks in a market in which aggregated performance has been lackluster to say the least.

Given these points, there are very poignant arguments to be made on both the bull and bear sides of the debate. While I appreciate management’s ability to generate such a large subscriber base and while I commend the bulls’ insight and risk tolerance over the years, I think investors need to be very careful in this name.

While I wouldn’t short it, I don’t think one can justify taking a long position, either — there are simply too many risks.

First, the market is pricing in a tremendous amount of growth, with the stock trading at over 100 times earnings. While this growth may be coming in the company’s future, investors who want to bet on this growth need to do so when the market is more pessimistic. The stock is priced for perfection, and generally you want to make an investment when some of the downside risks are priced in.

Second, I think bulls need to be concerned about competition. While Netflix has emerged as a leader in the sector, the fact remains that there are several companies out there that have the potential to compete with Netflix. Given this and given the company’s extremely high valuation, it wouldn’t take much of a perceived threat to knock the stock down significantly.

Finally, so far this year, and especially since March, a lot of high-growth stocks have been pulling back. I think that we can see investors who have growth-oriented portfolios start to scale back their appetite for risk, and they will look for opportunities to sell strength. Therefore, I think that while the price of Netflix stock may spike in the coming days, especially as short sellers rush to cover their positions, longer-term shareholders may decide to scale back their positions.

With these points in mind, I would be very cautious in Netflix’s stock. While there is a lot of opportunity, there is also significant risk, and it is unclear to me that the share price sufficiently incorporates it. Therefore, I think investors should take the post-earnings spike and take some chips off the table.

Disclosure: Ben Kramer-Miller has no position in Netflix or in any of the stocks mentioned in this article.

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