Guess What Just Joined My "Screaming Buy" List

Selling Netflix (Nasdaq: NFLX  ) today would be a big mistake. Huge. This is actually where you back up the truck.

The subscription-based video-rental specialist reported third-quarter earnings last night. The market hated every word of it, and share prices plunged as much as 39% overnight. We're back to prices last seen in April 2010. Shares have tripled and then given it all back in less than 19 months.

Along the way, the company and CEO Reed Hastings made some big mistakes. In my opinion, they have all been corrected as of last night:

  • The Qwikster debacle came and went so fast, all it left behind was a batch of canceled accounts and a dent in Hastings' public image. The defectors may or may not come back after looking for alternatives to Netflix streams in Amazon.com (Nasdaq: AMZN  ) Prime or DISH Network's Blockbuster service. The PR damage was Hastings' problem to own and repair.
  • In my opinion, he did plenty of that in this earnings call. Netflix lost more subscribers than expected from drastic price changes and the Qwikster thing, but Hastings won't panic and overreact. "The focus for us is in building back our reputation and brand strength," he said. "But that's not through grand gestures, signing some crazy content deal or doing something else. It's the same set of steps that we've been using year after year for the past 10 years in terms of building our brand, which is a steady focus on execution, improving our service quarter-after-quarter."

In other words, regaining those lost customers is a matter of blocking and tackling. You don't change a winning concept. That's exactly what I wanted to hear.

The cherry on top might surprise you? Netflix will stop buying back shares. The buyback always looked like a terrible idea when the money could have been spent on content licenses or heavier marketing instead. That's exactly what will happen now.

Buybacks are often very shareholder-friendly moves. But that's when mature businesses do it. Intel (Nasdaq: INTC  ) is famous for a staunch commitment to buybacks and raised dividends. IBM borrows money to buy back shares, and it's an appropriate use of funds.

But Netflix should have been pouring that money into content deals or marketing all along. It may seem counterproductive to stop the buybacks now that shares suddenly look cheap again, but this policy should never have existed in the first place. I'm just glad to see Netflix come to its senses.

The downside
It wasn't a slam-dunk perfect report, of course. Cancellations are lingering into October and flattening out in November, leaving lots of rebuilding work to be done in the holiday season. Moreover, the international expansion is slowing down until lessons have been learned from the British adventure. I'd prefer a quicker push across Europe and into Southeast Asia, but that's not what we're looking at here.

Earnings may turn negative in 2012, at least for a couple of quarters, as Netflix builds out its service in the British isles. If that happens, the stock may sink even further thanks to shortsighted traders who miss the forest for the trees.

Netflix could keep earnings in the black if it wanted to, but at the cost of less marketing and fewer content additions, and that's not how you build long-term growth. Need I remind you once again that Netflix has full control over the bottom-line numbers, even if the top line isn't always predictable? So red ink on the bottom line simply means that the company chooses to forge ahead with high-octane growth, even if analysts would prefer stable earning and slower growth.

That's exactly the right thing to do.

Take the right action
So here's the deal. You can stare yourself blind on a temporary loss of subscribers, which will be forgotten a year from now. You can panic over the prospects of negative earnings, which also won't leave any lasting damage. And then you can sell Netflix, locking in all the damage -- real and perceived -- of the past few months. I don't think that's a good move at all.

Or, you can ignore the potential earnings stumbles and look ahead to astonishing results in the future. Don't forget that the Canadian service hit breakeven after just a year, and then think about what Netflix's international numbers will look like in 2015 and beyond.

I was waiting for signs that Hastings still had his head screwed on straight before calling Netflix a buy again. I think it's obvious today that he's as sane as ever, and the shares have become mouthwateringly cheap as well. Mind you, they may still fall further in 2012, but that doesn't make the long-term profit opportunity any less tempting.

There you have it: Netflix is a screaming buy today, right next to widely misjudged camera-chip maker OmniVision Technologies (Nasdaq: OVTI  ) and audio specialist Cirrus Logic (Nasdaq: CRUS  ) . That's the triumvirate of insane values I'll be choosing from the next time I have capital to spend. They should all be on your buy list as well, or at the very least on your Foolish watchlist in case you're looking for even better starting prices:

Fool contributor Anders Bylund owns shares of Netflix and a synthetic long position in OmniVision but holds no other position in any of the companies mentioned. The Motley Fool owns shares of Cirrus Logic, IBM, and Intel. Motley Fool newsletter services have recommended buying shares of Amazon.com, Netflix, and Intel, and creating a diagonal call position in Intel. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Check out Anders' holdings and bio, or follow him on Twitter and Google+. We have a disclosure policy.


Read/Post Comments (7) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 26, 2011, at 12:16 AM, AnkurVarsheny wrote:

    I think you thoughts are mostly foolish as the name suggests. Netflix is on the way down and its has given enough chance for competitors to gain strength. It is in a space where trend changes very fast. I hope you remember blockbuster don't you?

  • Report this Comment On October 26, 2011, at 2:49 AM, TradeDragonfly wrote:

    Something people seem to forget is that this company's problems are real. To understate them is to do yourself a big injustice. Subscriber loss? That's a big deal. Content loss? Also a big deal. This company is in some real trouble and it's funny to me to come to this site and watch all these people who've fallen in love with the stock to say how much they think it's a buy. Don't kid yourself, and look at the issues, not the price. They are expanding into other countries, but there are a lot more headwinds there than people give credit for. I am watching this company closely because I think there may be a buying opportunity sometime within the next few months/quarters, but for right now, my advice is to watch the news and read the financial reports carefully. Beating wall street expectations isn't a feat when they revised them down several times. Now isn't the time to be emotional about a stock, but to sit back and look at the fundamentals and the change in the business model (which is imminent or the company cannot continue to operate this way). Just be careful and don't throw your hard earned money at a company that has more problems than things going right for it. It's a great service, but the execution of the executives was terrible for PR. My current opinion is hold it if you got it and buy if it goes below $55 (about 9x 2013 earnings estimates, which will probably be revised down). If you miss it going up again, so what? There are plenty of other stocks that will do the same, but don't have the fundamental issues Netflix has.

  • Report this Comment On October 26, 2011, at 5:35 AM, TMFZahrim wrote:

    @MYPIX, to address the twin dragons of subscriber loss and content loss:

    * Netflix is still adding new gross subscribers as rapidly as always. The loss is in the handful (OK, big handful -- couple of million) of unhappy customers jumping ship. The shakeout is winding down as we speak and then becomes a mere blip on a long-term graph. Yes, I remember Blockbuster and how Netflix was supposed to die when Total Access was launched. That was another "screaming buy" opportunity, obvious at the time and also in hindsight.

    * Content loss, really? Netflix walked away from Starz, which I assume is what you're talking about, because Starz wanted Netflix to become an online cable channel with tiered services where you'd pay extra for Starz access. That money will go into new deals elsewhere. Did you catch the part where streaming content spend is set to double next year to match industry leader HBO's content budget? Those dollars are buying content to replace Starz and then some -- or a lot.

    It would be nice to keep riding Starz' Sony and Disney deals, but nobody (not even HBO) has access to everybody's catalogs. I don't see any "content loss" happening here, but quite the reverse.

    Anders

  • Report this Comment On October 26, 2011, at 5:01 PM, TradeDragonfly wrote:

    I don't disagree that this may be a buying opportunity, I am just a bit more cautious than you based on what I see. I feel like there is a bit more downside to this than is currently shown in the stock price, and at first people will probably play a bounce. As for the content loss, Starz is higher quality than what they are replacing it with, which in turn results in less satisfied customers. We may just disagree in this matter, but I'm trying not to discount the problems here to save my money.

  • Report this Comment On October 26, 2011, at 8:15 PM, fiese wrote:

    I'm sure glad I sold Netflix earlier this year. It was just requiring too much attention. Quadrupled my money and walked away happy.

    In all the analyses I've read, I haven't seen what I think is one big reason so many subscribers defected. Automatic monthly subscriptions like Netflix are "set it and forget it" for most people. Netflix made everyone think about and make a decision about their subscription. Big mistake.

  • Report this Comment On October 27, 2011, at 12:27 PM, ikkyu2 wrote:

    Did you hear what you just said? You told your audience that it's time to back up the truck and buy Netflix shares now. You also told us that Netflix's plan to stop buying shares now, after having been buying them all the way up to 270, was a bad plan.

    Which is it? Buying shares now is a good use of capital, or not? Make up your mind.

  • Report this Comment On November 30, 2011, at 4:09 PM, nickhanderson wrote:

    Amazon and Apple are real threats to Netflix, but as of today Netflix still offers the best value and selection to the consumer. Single views from Apple can cost more than six bucks as compared with $7.99 for an unlimited monthly streaming subscription from Netflix. Some bad PR and some public gaff’s on the part of Netflix but I keep my Netflix subscription because everything else is more expensive and has less content. People seem to forget that when Netflix doubled their price lots of customers such as myself didn’t care because we only ever streamed anyways and so for us the price of the service never changed.

    It seems strange that only a few months ago analysis seemed to think that $300 was a good target for price and now those same people think Netflix is worth less than $60. It’s still a great service. At the time Blockbuster filed for Chapter 11 there were many cheaper, more convenient alternatives. I’m remaining optimistic about Netflix because as of right now there is no other service that seems better.

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