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Netflix: With a fall of nearly 30% this year, could there be a buying opportunity?

Tuesday, February 9th, 2016

Netflix (NFLX) stock was one of the biggest gainers in 2015. The company’s stock appreciated from an opening price of $49.15 on January 2, 2015 to a closing price of $114.38 on December 31, 2015. That’s a total return of 132.7%. With such a strong performance in 2015, will Netflix continue to see its stock price surge in 2016?

Taking a look at Netflix year-to-date, the stock price has fallen approximately 30% and now trades at a price of $82 per share. Warren Buffet is famous for saying, “Be fearful when others are greedy and greedy when others are fearful.” With the stock down nearly 30% for the year, it is clear that many investors are fearful and beginning to lose faith in the company’s ability to continue its growth. But is now the time to buy?

Many investors tend to abuse the advice mentioned above from Warren Buffet and see a pullback in a company’s stock price as an automatic buying opportunity. This misconception is driven by investors playing the stock market game versus understanding the value of the business.

The first step an investor should take when seeing a big pullback in the stock price is to check the fundamentals of the company and understand what you are truly investing in.

Looking at the valuation ratios for Netflix, one can see the company is extremely overvalued. The company recently reported results for the 2015 year, reporting earnings-per-share of $0.28. This produces a P/E ratio of 294.85 for the company. This is extremely high, as the industry average is 24.25.

Looking on a forward basis, Netflix is expected to make $1.06 for 2017. This produces a forward P/E of 77 which is well above the forty-year average of 16.5. Price-to-sales for the company is currently 5.23, which is more than double the industry average of 2.11. The company’s price-to-tangible book value is currently not material, which tells me they have a lot of intangible assets on the balance sheet.

The intangible assets are not the only area of concern with the balance sheet. Netflix currently has total debt of $2.4 billion. That produces a high debt-equity of 106.65. In 2015, Netflix had negative cash from operating activities of 750 million. Coupling high debt with negative cash flow is not an equation for success. If they cannot manage to produce cash from their operating activities, they will burn through the cash they borrowed and incur even more debt.

Netflix is currently classified as a growth stock. This means it does not trade on the underlying fundamentals of its earnings, but instead on the prospects for future growth. This is concerning because the risk on these high flying growth companies is extremely high.

Personally, I do not have a crystal ball and cannot predict the future. I am not sure how fast Netflix will grow or if it even will for that matter. I would rather invest in a company that is stable, undervalued and produces a healthy profit for its investors.

With growth companies, when the lack of hype and excitement starts to fall through the stock price will fall with it. You could see that 100% gain quickly evaporate into nothing. The tech boom and bust serves as a time period where many new “cool” companies saw their stock prices quickly elevate and then deteriorate shortly after. An example of this is Microsoft, who fell victim to the swing of the tech boom and bust. 

In the above chart you can see Microsoft saw a quick appreciation from below $20 in January of 1998 to nearly $60 by December of 1999. During this time period it was trading at a P/E above 70.

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