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This Is Why Critics of Netflix Stock Have It All Wrong

Nicolas Chahine

The death of Netflix (NASDAQ:NFLX) stock is greatly exaggerated. With all of its competitors being miles behind, NFLX is the company to beat in the online streaming sector. And this is my trade thesis in Netflix stock for the next few months.

Let me explain.

As we all know by now, Netflix stock has taken a significant beating since its earnings report, but most of this was due to timing. The selloff in NFLX happened while Wall Street was in a phase where sellers were in control from global fears.

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Netflix fell 35% off its July highs, but the fall was not straight down. On every swing low, the bulls managed to recapture half of the dip. The most recent fall was from the strong earnings report. NFLX stock investors sold it down almost 30%, but it has since recovered half of it.

So the idea is that this is a broken company and Wall Street thinks Netflix is a loser. My bet is that they are wrong. Uber fans of Netflix stock and perma-bears are both wrong, actually, and somewhere in the middle lies the truth. So my enthusiasm for the stock is tempered, but there is still a lot of upside potential to it.

The Nextflix stumble is not all intrinsic to its fundamentals. This is a momentum stock and they tend to move fast in either direction, which makes them hard to trade. They never give traders a clear entry point. On the way down they look like they are falling into an abyss, so the myth that it’s dead money grows quickly.

Perception is not reality, however. While sentiment is that this stock is a forgone loss, year-to-date, NFLX stock is still up almost 60%, while the Nasdaq Composite is struggling to hold the flat line.

Fundamentally it is expensive. NFLX sells at a 107 price-to-earnings ratio. This is even more expensive than Amazon (NASDAQ:AMZN) and more than twice as expensive as Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL). Apple (NASDA:AAPL) and Facebook (NASDA:FB) are five times cheaper, so one can argue that it’s bloated, even after this big correction.

But this is not a value trade. Netflix stock is a hyper growth stock, so I don’t really need to see value to trade it. Yes, it burns a lot of cash to generate content, but that is its best ace up its sleeve. Their shows are in demand and people are signing up in droves. This is not a U.S. story. Its global expansion was once in doubt but no longer. They are succeeding abroad too and this is a big world.

Media experts tend to measure metrics in terms of household to evaluate potential. NFLX is a personal experience; it’s a device metric not a household. So every smart phone on the planet is a potential customer and that is a massive number. The leader in the space is best set to gain the business and, for now, that’s Netflix.

There are reasons to worry for the long term. Competition is fierce, especially from Disney (NYSE:DIS) and the mega social media companies like GOOGL and FB, but I believe that management is up to the task. When everyone is busy playing catch-up, NFLX is aggressively implementing its expansion plans globally and it has a lot more room to run.

Bottom Line on Netflix Stock

The stock market in general was also responsible for a lot of the selling in NFLX stock and once that abates, the rebound to the highs is more likely than not. From here, there is more upside opportunity in the stock than downside risk. Even though it is still not cheap, it has already shed a lot of its top froth.

Technically, when it fell into the $280 prior pivot zone, it found support. While this makes for a good base to build a rebound rally, it also marks a risk. If it’s lost, then sellers could target $220, where there is an open gap from the earnings of last January. This is not a forecast, but a scenario that could be in play.

So at the risk of not picking a perfect spot to enter, I don’t take a full position all at once. After all, we still have the U.S. Fed’s decision tomorrow and the China trade war headlines are still abuzz. There is plenty of issues to fret, but meanwhile there is still potential in quality companies with hampered stock prices.

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Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on Twitter and Stocktwits.

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