Foolish Forecast: Nudging Netflix

With its stock price now up more than 150% over the last year, rival Wal-Mart (NYSE: WMT) exiting the DVDs-by-mail game, Blockbuster (NYSE: BBI) on the ropes, and Amazon.com (Nasdaq: AMZN) still avoiding the carnage, can Motley Fool Stock Advisor pick Netflix (Nasdaq: NFLX) possibly go higher? Or is all the good news baked into the stock price? On Monday, we'll get a chance to ponder the possibilities, as Netflix returns to Wall Street with news on its Q1 2006 numbers.

What analysts say:

• Buy, Sell, or Waffle? Sixteen analysts follow Netflix. Of these, seven rate the stock a buy, six a hold, and three a sell.
• Revenues. Better sit down for this. The analysts expect sales to rise 44% when the numbers come out tomorrow. $221.3 million is the target.
• Earnings. They're also expecting last year's loss to turn into a $0.06-per-share profit this time around.

What management says:
Netflix management was nothing short of exuberant over last year's results. Said CEO Reed Hastings: "2005 was another year of solid achievement. ... We generated rapid subscriber growth . ended the year with the lowest churn in our history, and delivered both rapid growth and strong earnings. ... We enter 2006 confident we can reach our goal of 20 million subscribers within the 2010 to 2012 time frame, while delivering $50 million to $60 million in pre-tax income this year and 50 percent year-over-year earnings growth for the next three to four years after that."

What management does:
Achieving those lofty goals will require two things from Netflix. First, it must continue growing its subscriber base, both by stealing market share from arch-rival Blockbuster and expanding the size of the DVD-by-mail market in general. Second, it must capitalize upon the advantages it gets from growing -- "economies of scale," for you Econ 101 students -- by enlarging its margins and making each dollar of revenue a bit more profitable than the last.

Margins %	9/04	12/04	3/05	6/05	9/05	12/05
Gross	34.2	34.1	32.6	32	30.7	31.9
Op.	7.3	7.2	5.8	5.5	3.2	3.6
Net	4.1	4.3	3.3	3.5	1.5	6.2

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ending in the named months.

One Fool says:
Netflix clearly has the revenue part of this equation nailed. At 10 years old, Netflix is still growing revenues in the low-to-mid-double digits. But the above chart suggests that the company is having trouble expanding its margins. Although $42 million in legal settlements and tax credits arrived in Q4 in time to considerably boost its net margin, Netflix's trend in gross and operating margins has a seriously downward slope.

I suspect the two factors are related. Revenues grew 30% year over year in the last six months, and the cost of those revenues grew only 31%. Operating costs (read: getting new subscribers) really pressured operating and net margins, rocketing 43%. That's yet another trend to put in your must-watch queue.

Other competitors:

• Best Buy (NYSE: BBY)
• GameStop (NYSE: GME)
• Movie Gallery (Nasdaq: MOVI)

Netflix , GameStop, Amazon.com, and Best Buy are all Motley Fool Stock Advisor picks. For more superstar stocks from Tom and David Gardner, sign up for a 30-day free trial.

Fool contributor Rich Smith does not own shares of any company named above.