After spiking over 10% in early trading Tuesday, shares of Netflix (NFLX) plunged midday, burying investors who chased the stock higher. Shares briefly hit $400 after-hours on Monday after the company reported profits of $0.52 and guided higher for the balance of the year. By Tuesday afternoon shares were down more than 6% and closer to $330 on massive volume.
Some profit-taking is to be expected on the best performing stock in the S&P 500 (^GSPC) this year, but the reversal is looking more convincingly bearish as the day progresses.
Michael Pachter, managing director of equity research at Wedbush, says Netflix shareholders should get used to disappointment, because the business model simply doesn't support where the stock is trading. "They did $1.1 billion in revenue and they generated $7 million in free cash-flow." Lousy as those margins are, Pachter says they're going to get worse.
All the surprisingly good original content Netflix has been able to produce comes at a steep price. Now that Netflix original content is a proven hit, it's going to get much more expensive for the company to deliver future seasons of "Orange Is the New Black" or "House of Cards." Emmys are great but they don't pay the bills. "People are getting a little skeptical about whether this company is ever going to generate a lot of positive cash flow," says Pachter.
Not that Netflix bulls should expect any sympathy. The more than fourfold gain over the last year even had CEO Reed Hastings sounding cautious during last night's conference call. "Every time I read a story about Netflix is the highest appreciating stock in the S&P 500 it worries me because that was the exact headline that we used to see in 2003,” said Hastings. "We have a sense of momentum investors driving the stock price more than we might normally. There's not a lot we can do about it but I wanted to honestly reflect upon that.”
Pachter concedes Netflix offers a great service and a compelling value for consumers, but the stock is simply too expensive. To get anywhere near current levels on a fundamental basis Pachter says Netflix would need to raise prices by $4 a month across the board, keep content costs static and see no customer attrition. "Props to them," offers Pachter. "[But] I don't think those things are going to happen, so I still think the stock is over-valued."
Pachter "grudgingly" (his word) raised his price target to $160 this morning. That's as far as he's willing to go, and it's about 50% lower than where Netflix is trading at the moment.
Regardless of how the movie ends on this particular rally, investors can't say they weren't warned.
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