Where Is Netflix Weakest After Strong Earnings?

Netflix (NASDAQ:NFLX) soared as much as 24 percent on Tuesday after the video-streaming subscription service reported first-quarter results that blew the socks of investors and analysts alike.

Revenue climbed 17.73 percent to $1.02 billion, in line with expectations. Earnings climbed from a loss of $0.08 per share in the year-ago period to a gain of $0.31, way ahead of the average estimate of $0.18. The company signed up 2.03 million new U.S. streaming subscribers to end the quarter with 29.17 million domestic subscribers.

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To put it lightly, the stock has been on a tear over the past 52-week period. Including Tuesday’s gains, shares are up more than 111 percent year over year. The stock is finally closing back in on all-time highs hit in July of 2011.

But it’s not all sunshine and happiness at the company. Michael Pachter, an analyst at Wedbush Securities with an Underperform rating on the stock, suggests that as many as 10 million people are using the service without paying. This, of course, is bad for business…

“It’s time to change,” Pachter said in an interview with Bloomberg. “They can say they’re cracking down on piracy. They can appeal to fairness. It’s great if the parent has a subscription and the kid watches it in the college dorm.”

As it stands, Netflix allows a single account to stream in two locations simultaneously. Technically, there is a limit of six authorized, Netflix-ready devices per account, but this policy isn’t strictly enforced. In the eyes of analysts and investors, this represents an untapped revenue stream.

The reason this untapped revenue is so important, Pachter said in a post-earnings note on Tuesday, is that “cash flow remains negative. This suggests to us that content costs continue to rise, but are not amortized until later, meaning that net income will drop in future periods.” In summary, Netflix could really benefit from people actually paying from the content they watch.

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“In our view, much of the recent subscriber growth is an acceleration of subscriptions that would have been sold later in the year,” said Pachter. “Accordingly, we expect Netflix to face a headwind in Q3 and Q4. We expect the benefit of originals House of Cards and Arrested Development to reverse when original content dries up in the third quarter.”

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