The movie is over for Netflix

Run screaming for the fire exit if you own Netflix stock, because it's about to tumble

By InvestorPlace Apr 22, 2010 7:34AM

By Ed Elfenbein, editor of Crossing Wall Street.

family watching netflix movie on tvLots of folks on Wall Street want to know which stock to buy. Today, I want to look at the absolute worst one to buy. My friends, that stock is Netflix (NFLX).

Now before anyone says that I’m being mean to the company, please bear in mind that I’m not offering a judgment on the managers or the employees. There’s a big difference between a good company and a good stock. Netflix has a business record that anyone should be proud of. The stock, however, is terribly, terribly overpriced.

Let’s look at some numbers. Last year, Netflix made $115.9 million of sales of $1.67 billion. That works out to earnings of $1.98 a share. The stock, however, is currently around $86 or 43 times trailing earnings. The shares were overpriced at the start of the year and they’re up another 55% since then. Post continues after video:

When the fourth-quarter earnings came out in January, Netflix said that it expects full-year earnings-per-share for 2010 to range between $2.28 and $2.50. So even going by the top end of forward earnings, NFLX is still trading with a P/E ratio of around 35 which is more than twice the S&P 500. That’s just crazy.

Netflix also said that it expects revenues between $2.05 and $2.11 billion. That’s a growth rate of 23% to 26% which is slightly better than last year’s 22%. The problem with the valuation is that a lot of NFLX’s earnings growth has come from profit-margin expansion.

That’s a very good thing to have, but I’m skeptical of how much more that can improve without the company exposing itself to potential rivals like movie vending machine company Redbox. On top of that, business could be hurt by higher postal rates and the elimination of Saturday delivery. Also, companies like Walmart (WMT), Amazon (AMZN) and Best Buy (BBY) loom in the background.

Netflix’s net margins improved from 5.6% in 2007 to 6.1% in 2008 to 6.9% last year. Earnings are coming out tomorrow and it could be bad news. I have little doubt that the company will top the Street’s expectations of 54 cents pet share. In January, Netflix said to expect Q1 earnings between 47 and 58 cents per share. With the stock so high, NFLX has zero room for error. The stock is simply far too high to expect a reasonable return.

If you own Netflix, you ought to sell it as soon as possible. The next 12 months won’t be pretty.

netflix nflx stock chart

The chart above has NFLX's stock in the blue line which follows the left scale. The right scale has the EPS line which is in yellow. The two lines are scaled at 20-to-1 which means when the lines cross, the P/E Ratio is exactly 20.

Ed Elfenbein is editor of Crossing Wall Street, a Web site about stocks and the market designed to help individual investors. Check out his free Buy List of stock recommendations. As of this writing, Ed did not own positions in NFLX.

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