I love the Netflix service. I swap tips about various Netflix series with friends and the company basically owns my living room, but I’m bearish on the stock.
Netflix represents the “N” in the “FANG” gang, a group of former market leaders that has been leading to the downside this year. NFLX was the worst performer in the group on Thursday (-4.5%) and is the 2nd worst performer year to date (-20%) after Amazon (-22%).
One reason these two are lagging the group is that both NFLX and AMZN have triple-digit trailing P/E ratios, whereas FB and GOOGL have more normal valuations.
Apart from the P/E ratio, there are additional fundamental reasons that shares of NFLX are relatively weak and likely to take over the lead to the downside. Facebook, Amazon and Google/Alphabet have very strong balance sheets and generate robust free cash flow, as measured by cash flow from operations minus all capital spending.
Facebook has $18 billion in net cash, no debt and posted $6 billion in free cash flow last year. Alphabet has around $67 billion in net cash and free cash flow of $16 billion. Amazon has twice as much net cash as debt and $7 billion in free cash flow.
Netflix, however, posted a negative free cash flow of $900 million in 2015, with total cash now equal to debt. The company is growing like a weed, as is Facebook, but paying hugely for that growth. The new markets Netflix is expanding into are not premium markets, so pricing may be an issue, further crimping margins.
Having been the best performing stock in the S&P 500 in 2015, Netflix is now in the bottom 10% of that index year-to-date and would rank lower if it were not for the dismal performance of the energy sector, where YTD share price losses average 30-40%.
In bearish regimes, unfilled gaps are the technical targets. NFLX has a large price gap around $75, which is my immediate target. However, the combination of high P/E and a weak balance sheet makes NFLX likely to overshoot this target and reach the $60-$65 level.
The only question is whether this decline happens now… or from a higher level. If the general market can continue the current bounce, NFLX has the potential to reach $105 on a continuation of the short squeeze (14% of the float is short). A sudden move above $95 will signal that. Otherwise, the stock is likely to perform more like a rock than a rocket over the next few months.
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