Top 10 Most Shorted Stocks - Netflix

By Chad Henage - February 12, 2012 | Tickers: AMZN, NFLX | 0 Comments

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A recent survey of the top 10 most shorted stocks in the S&P 500 found Netflix (NASDAQ: NFLX) coming in at #5. The company currently has about 21.79% of its outstanding shares sold short. My contrarian nature makes me think there might be opportunity where others see problems. Let's look at Netflix a little more carefully and see what's going on.

Netflix

Current Price: $123.07
P/E on '12 highest earnings estimate: 129.55
Growth expected: 17.88%
PEG: 7.25 

I have to add a few caveats to the numbers above. First, I used the highest estimate for 2012 because the average estimate calls for a loss. If you are a Netflix bull, notice I've already been more than generous. The highest estimates are for $0.95 in 2012 and up to $4.06 in 2013. The range of estimates for Netflix makes it nearly impossible to tell where earnings will land. The bull case says that if Netflix met these highest estimates, the future P/E would drop from 129.55 to 30.31 in the next two years. While this is the bull argument, this could also be the bear argument at the same time. For Netflix to reach a more reasonable price, the stock would have to stay the same for the next two years. The company would also have to come in at the highest earnings estimate for both years. Netflix is still a growth company. However, asking a company to post the highest earnings estimates available, for two straight years, is a difficult request.

If you are looking to short Netflix I would point out a few facts. First, the stock is down nearly 60% from its 52-week high. Second, the stock has been as low as about $64 and appears to have support at least at $85. The stock is so volatile that either position, long or short, is not for the faint of heart. With a stock that was down nearly 80% from its 52-week high, you have likely missed the best time to short the stock.

When it comes to earnings, you can expect the company to beat expectations on a regular basis. Netflix has beaten estimates in each of the last four quarters by an average of 18%.

In addition, the company is currently cash flow positive. Netflix shows positive cash flow over the last four quarters averaging about $74 million a quarter. The company did repurchase shares, but then reversed course and issued new shares. Where Netflix balance sheet is concerned, the company's long-term debt has stayed flat over the last year. Currently, the company shows a 0.60 debt-to-equity ratio.

Netflix competitors are well documented. Netflix's primary competitor would arguably be Amazon.com (NASDAQ: AMZN). Amazon.com already offers over 15,000 titles through its Amazon Prime membership, and the expectation is for a separate streaming service apart from Prime to be offered. As a side note, if Amazon doesn't come up with a queue system for these streaming videos the service is doomed from the start. Amazon currently sells for $185.29 a share, which gives the stock a forward P/E of about 141. Amazon is expected to grow faster than Netflix with future growth at 28.38%. At this point, if you are going to pay over 100 times forward earnings, Amazon seems the better choice.

In order to go long Netflix here, you have to believe that Netflix will crush estimates going forward. Anything less than the highest earnings expected from Netflix could cause another downdraft in the shares. If you are shorting the stock here, you are waiting for another shoe to drop. However, with such a volatile stock, if that other shoe doesn't drop you could be the one on the wrong side of this trade. I'm not comfortable with Netflix's multiple here, but I would not be brave enough to short the stock here either. Let me know what you think in the comments section below.

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