Sunday, August 15, 2010

Why I refuse to short Netflix?

Now, this is certainly an interesting stock! I have never played it but everybody certainly seems to have an opinion about it. I find this stock interesting from the trading psychology point, hence the complete post about it. But first things first. I have heard a lot of chatter, and I am sure you have too, about how grossly overvalued this stock is. Being no expert on fundamental analysis myself, I requested one of the regular readers of this blog, Bill, to give me his analysis on the fair value of this stock and this is what he had to say - 

"From a fundamental perspective i would say they are a hold at best and personally i would sell if i owned stock. The positives are that they are growing from operating cost reduction (also an upcoming mail-less Saturday will add to this operating surplus) and their balance sheet doesn't have a lot of choppiness to it which is comforting to investors for solid long-term growth. The negatives are that the operating cost reduction was b/c of decreased delivery cost to costumers which means they are shipping less dvd's. This could be good if consumers still maintain the same monthly rates but they are downgrading to the lowest price package which is 8.99 (one dvd and unlimited online) instead of 14.99 (two dvd and unlimited online). And i can relate to this b/c that's exactly what i did with my subscription, with the emergence of redbox and VOD the need for instant dvds from netflix is fading and the demand for more instant online content is heating up. If netflix doesn't find a way to generate more income from the online portion they will fade into the distance like blockbuster as newer cheaper version will eventually emerge and people will flock to that. Especially since the online content they have now will not satisfy the masses forever, which is why making deals like EPIX but they come with a hefty price tag. And if that deal doesnt generate new subscribers then they just paid 1 billion to make their current customers happier.
One other negative is the just added about $200 million in debt last year as apposed to the $36 million they had before, that may have been partly to finance the EPIX deal but it may the beginning of a larger debt accumulation. Ultimately my analysis of this stock comes down to the P/E and the beta. P/S and P/E indicate this stock is trading about 4 years out in estimated growing profits at almost 55 times current earnings. I wouldn't bank on any company keeping growth rates consistent for 4 years so Netflix is no different, but the beta for the stock is .52 which is shocking considering the run up and the %6-8 daily moves. This leads me to believe that even though the stock price is dreadfully overinflated it doesn't look like its going to fall off a cliff. However i think its fairly close to its top which i would put around $140-$145, so there's more downside potential than upside. I would say short term the stocks moves to around $139-$140 in august but 6 month outlook i see it moderating to around $95-$110. Its a little difficult to peg a price b/c it moves so quickly but when you see people piling on to the stock even on bad days for the market and the sector, it doesn't usually bode well for an extended period of time."

Thanks for the wonderful analysis Bill! Seems like pretty good stuff to me. I am sure most people out there agree with Bill's analysis here.

BUT I have seen a lot of very fine traders short this stock and lose handsome amounts of money in this stock. The damned stock keeps going up!! Like I said, I am sure the stock is overvalued and am not arguing with that. But the bottomline is that if you are a short term trader, you gotta trade what you see and not what you think. Always keep this in mind, the market can stay irrational a lot longer than you can stay solvent. If you are a long term trader, like I am guessing Bill is, you can start taking small short positions, but even then, no matter how confident you are about your analysis, you gotta respect your stop loss on a stock with strength such as this. Back to the short term stuff now. Let's have a look at the chart now.

The stock gapped below MA(50) on its earnings report. Technically, that was an excellent short opportunity. But in the next few trading sessions, the stock started basing and regained MA(50), tested it and away it went to form new highs. Now, you gotta respect that. Just as one should not go long a stock which comes out with excellent news but still can't manage to go higher (think Intel), one should not short a stock which goes higher on negative news. Now, in the course of time, the stock might go down to its fair value and in hindsight, this might prove to be an excelling shorting opportunity. But my point is why would you want to short a market leader which goes up in spite of bad news rather than the hundreds of beaten up stocks that are out there. Agreed, shorting and making big money on a stock like this might be a lot more satisfying intellectually than shorting an already beaten down stock, but the markets are a place to make money, not to satisfy one's intellectual needs. I would rather be wrong and make money than be right and lose money. 

Now that I have had my say, let me just end with a couple of lines on technical analysis of the stock. I love the volume pattern that has emerged in the last ten days or so. The stock does look overextended and I would like to see a successful test of 128 before going long. Some consolidation here would do the stock no harm here. But again, I would not short this stock for reasons underlined above.

Take care and good luck!


Doctor Stock said...

This is a great example of why investors have to watch the overall market momentum... it pulls most stocks in the direction it is going. Furthermore, an individual stock's momentum also leads the way... like it or not, technicals often override fundamentals (at least in the short term).

Bill said...

I completely agree with your analysis, excellent post. Its hard to pick a top for this stock right now and most people don't want to. I also agree that technicals will override fundamentals until this stock has a catalyst to push it back to earth but i really don't see that coming until at least next quarter especially with analysts constantly disagreeing on the direction of this stock. Until a consensus is formed this baby is a train without brakes.

Thanks positiontrader really appreciate that one! Don't quit your side job, your pretty good at it.

positiontrader said...

Thanks for the kind words Bill! And once again, thanks for the analysis. If you don't mind, I am going to bother you if I need any stock checked fundamentally in the future :).

Hopefully, the side job can turn into the main job someday in the future. Sigh!