Netflix Wants to Stream Your Money Away

Eric is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Are you streaming your money down the drain when you invest in Netflix (NASDAQ: NFLX)?
The video services company’s stock price is pushing back toward $200 on nothing but analyst recommendations that seem to have little grounding in stock investing fundamentals.

The most basic components of fundamental analysis are earnings per share and price to earnings ratio. Netflix stock fails any test using these basic analytical techniques. Let’s look at the facts

Netflix earned $.29 per share last year and the average of analysts’ estimates comes in at $1.37 for 2013 and $2.99 for 2014.  These EPS numbers give us price to earnings ratios of approximately 586, 124 and 57.  Compare this to Google (NASDAQ: GOOG) which has a current PE ratio of 25.

Google is a growing company with little competition in its main markets.  Netflix faces growing competition in its main markets.

Do you think Netflix deserves such a vastly different multiple?

Examine the competition. (NASDAQ: AMZN), through its Amazon Prime membership service, is steadily coming after Netflix.  Amazon will not stop until it becomes the dominant service and there is not much Netflix can do to stop them because Amazon can afford to take a loss while scooping up customers. That is how Amazon has historically treated competition and they have yet to lose.

Netflix also faces stiff completion from Coinstar's (NASDAQ: OUTR) new Redbox Instant. Redbox Instant is a joint venture with Verizon which has very deep pockets and a huge subscriber base for cross marketing.  Redbox Instant combines DVD rentals from the network of Redbox vending machines with a streaming service.  Verizon could easily slip in Redbox Instant as a bonus to its millions of existing customers as a retention tool.

If those two competitors weren’t enough, every cable, satellite and content creation company has or is developing its own kind of streaming.  Time Warner Bros., holders of one of Hollywood's largest content libraries, just announced a new service called Warner Archive Instant. Google, Apple and Microsoft all have the capital and the technology to enter the marketplace. 

Do you seriously think they will stay away if there is a buck to be made? 

How does Netflix look from the consumer’s view point?

Generally, the social media buzz on Netflix continues to be negative. 

Most of the dissatisfaction centers around the small amount of recent releases available for streaming and 30 day delayed availability of many new releases for the standard DVD service.  There are also many comments regarding a decrease in available titles in the DVD library.

DVD rentals are the most profitable part of Netflix business and profit from the DVD through the mail program have steadily been falling.  Netflix lost around $75 million in profit from the DVD service last year.  If consumers cut back even more, where will the money come from to fund the increasing costs of locking up quality content for distribution?

Why, in this environment, does Netflix deserve a PE ratio of 57 time earnings two years out?  No good reason that most fundamental analysts can see.

Most fundamental analysts do not see how Netflix can put together the sustained profit growth for its share price to stay at these very lofty PE levels.The prevailing opinion is reality will eventually set in and the PE multiple will drop closer to Google's 25 times trailing earnings.

Even that could be too high. 

Netflix is definitely not a buy and hold stock.  The greatest profit potential exists in buying out of the money put options.

Eric Whiteside has no position in any stocks mentioned. The Motley Fool recommends, Google, and Netflix. The Motley Fool owns shares of, Google, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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