Roll Credits for Netflix

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An "outperform" call I put on Netflix (Nasdaq: NFLX  ) in April 2008 is my very best CAPScall to date, having racked up nearly 900 points. However, it's also a call I actually ended in July, when the stock was trading at $299.51. And now for a new, dire CAPScall: I'm afraid it's time to roll the credits on Netflix as a growth-oriented investing winner.

Disruption junction
The DVD disruptor is finally being disrupted itself, and it ain't pretty. Founder and CEO Reed Hastings made a slew of mistakes last summer, which catalyzed the ending of my positive CAPScall. Price hikes on their DVD-by-mail service, the ill-fated (and quickly abandoned) "Qwikster" phase … suddenly Netflix was no longer the darling hero compared to old-school DVD rental rival (and consumer villain) Blockbuster; it just looked a heck of a lot like its old nemesis.

Although the blunders came across horribly, I doubt those missteps were based on arrogance or stupidity. They occurred because Netflix's business outlook is changing dramatically. (Not that that matters to angry, disgruntled consumers.)

Netflix's original claim to fame was that it disrupted the DVD rental business, giving customers a far better experience. Well, now the actual DVD is being disrupted.

Perfect storm
First, one major problem for Netflix's physical DVD delivery model is that the U.S. Postal Service is an insolvent mess. The USPS boosted its rates recently as it worked to improve its financial situation. However, many of the things it could do to get its financial house in order would hurt Netflix's financial house. Slower delivery times for first-class mail or discontinuing Saturday delivery are some of the post office's money-saving ideas, but either would both make Netflix's DVD rental service a lot less satisfying.

Granted, eventually how quickly DVDs arrive (or how costly it is to ship them) won't matter. The future is digital. Granted, Netflix worked to get ahead of the game by offering (and strongly encouraging) subscribers to stream content. However, Netflix is most certainly not the only game in town anymore, and I don't believe it has anything close to the competitive moat it possessed in physical DVD delivery. (Nasdaq: AMZN  ) offers streaming movies through its Prime service. In fact, in the midst of writing this, I received a promotional email from Amazon boasting about 2,000 more TV shows and movies added to Prime Instant Video.

Cable and telecom companies like Comcast (Nasdaq: CMCSA  ) and Verizon (NYSE: VZ  ) offer on-demand options for media consumers. Further, as much as Coinstar's (Nasdaq: CSTR  ) Redbox was a formidable threat to Netflix on the physical DVD-rental front, that rivalry got more ammo last week when Coinstar announced Redbox will team up with Verizon to offer streaming titles along with a regular subscription service.

Add in all these issues with the difficulties in courting and keeping studios in their good graces (and offering streaming titles), and I've got a bad feeling about Netflix now. That "bad feeling" is compounded by the fact that the stock's recovered from its dismal lows and is currently trading at 50 times forward earnings.

Time will tell
I know that some of my colleagues, including many on the Stock Advisor team, still hold great belief in Netflix, even given the serious challenges the company faces. (Tom Gardner offered up a thought-provoking analysis in October.)

Still, as great a leader as Reed Hastings has been (annus horribilis notwithstanding), I'm not convinced Netflix can overcome the massive disruption it faces, not to mention defeat the hordes of eager rivals. I'm going to back up the "bad feeling" I have about Netflix with an underperform call on CAPS. (You can see my long-term track record here.) We'll see what the future delivers.

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Alyce Lomax does not own shares of any of the companies mentioned. The Motley Fool owns shares of Motley Fool newsletter services have recommended buying shares of Coinstar, Netflix, and Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (14)

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 February 14, 2012, at 8:24 AM, chadhenage13 wrote:

    The most recent forward earnings I've seen call for negative full 12 earnings. Where did the 50 times forward earnings come from?

  • Report this Comment On February 14, 2012, at 8:35 AM, Morgana wrote:

    To say that the US Postal Service is an insolvent mess is unclear. The US Postal Service, not a federal agency, has had unconscionable requirements imposed on it by Congress (I think the requirement is to fund pensions for two generations) . . . a problem that would not exist without THIS Congress--since they legislated that on the USPS--or at least a Congress that had a primer course in logic and another primer in normalcy. A change in that requirement would make the entire problem disappear and the USPS would again operate quite solvently.

  • Report this Comment On February 14, 2012, at 9:29 AM, MKArch wrote:

    The fact that their U.S. streaming business with over 20M subs or about 25% of the addressable market isn't even profitable might be a clue that there is no future for this unsustainable imposion in progress.

  • Report this Comment On February 21, 2012, at 1:45 PM, cattywampus wrote:

    I've had Moneyball in my Netflix queue since it came out and it is still listed as a (very long wait). I'm throwing in the towel and going to get it at the local Redbox. It has been highly recommended by the SA crew and deserves a look. I'll be exiting my DVD by mail portion of the service and keep the streaming for now. I,m not a big fan of rabid Pod Zombies who idolize stocks and the people associated with them. I do like people with vision who can project into the future and the past. Reed Hastings comes from a family that has shown that ability. Alfred Lee Loomis instrumental in the development of radar,Loomis Radio Navigation LRN or LORAN later developed into GPS, established a private lab at Tuxedo Park, New York where the likes of Einstein, Heisenberg (uncertain of his first name), Bohr, Franck and Fermi were invited and was friends with Vannevar Bush who appointed him to the National Defense Research Committee and established the Rad Lab at MIT. Just a drop in the bucket of the family accomplishments. The big picture playing on a screen near you. Maybe we'll have to call you and Moser Polaris A & B. Bleeker and Phillips do some good articles that are great reading. Your writing is always top of my list.

  • Report this Comment On February 22, 2012, at 12:30 PM, BlazerMania wrote:

    @ Morgana9-

    It is refreshing to read an intelligent comment about the USPS. You are absolutely correct. If Congress would simply remove the overfunding requirement, and if USPS would actually charge something more than the almost free postage most junk mail gets, the "problem" would be solved.

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