Why do thrill-seekers pay money to jump out of a perfectly good airplane? Why do seemingly normal human beings choose to climb those large rocks in the Southwestern U.S., stretching thousands of feet into the sky? Because "they're there"?
Similarly, why would investors, using their own hard-earned money, make the conscious decision to invest in Netflix (Nasdaq: NFLX ) , knowing full well they're taking the equivalent of the first step toward the world's wildest rollercoaster ride? The first two questions are obviously rhetorical, as there are no rational answers: Those people are just plain nuts. The question regarding Netflix, however, bears looking into.
October's wild ride just the latest
The 30% jump in Netflix share price month-to-date would, at first glance, seem to be a validation of sorts for the diehards. To its credit, Netflix has long boasted a staunch group of supporters who quickly come to the defense of the $4 billion streaming-video leader. Though not quite in the iCult category (yet), Netflix has clearly won over the hearts of many an investor. A look at the past week offers a glimpse of what it takes to get Netflix flying.
As my colleague Rick Munarriz alluded to in a recent article, another analyst upgrade, this one from Morgan Stanley, in conjunction with slowly improving customer ratings, started the latest Netflix trading mayhem. In addition to the aforementioned 30% jump in value since Oct. 1, trading volume went ballistic. Netflix started October trading an average of 3.6 million shares daily, already on the high end of the norm. By week's end, Netflix saw trading volume jump to more than 13.1 million shares. So, everyone just wants a piece of the tasty Netflix pie, right? Unfortunately, no.
That kind of volume is a pretty clear indication that day traders and momentum players want a piece of the Netflix action. For most Fools, that should be a worrisome sign. Finding financially solid companies, with sound business models and long-term growth and/or income potential, is the general theme of mid- to long-term investors. Then, there's the "get in, ride the wave, and get out" crowd. The latter group must absolutely love Netflix.
The start of trading on Oct. 9, when the stock opened about 7% down, shouldn't have come as a surprise to anyone who follows Netflix -- this is what shareholders, aka thrill-seekers, sign up for. Lest you think the latest Netflix ride is an anomaly, consider August. A nearly 20% jump in Netflix stock price came after a precipitous 35% drop (following the July 24 earnings call).
And let's not forget what became of yet another Netflix trading sensation -- the circuitous announcement by CEO Reed Hastings via his Facebook account that streaming hours topped 1 billion in June of this year. At the time, the Netflix stock price was at $67.85, with 1.85 million shares trading hands each of the first couple days in July. Then came the billion-hour news, and the ride started again, to the tune of a 23% jump in share price over the next week.
Netflix issues good news -- analyst upgrades, billions of viewers, improving customer relations -- and that's bad? No, not at all. The problems arise when we examine the news itself. The analyst upgrades and other assorted "goodies" all share a common theme -- there's no substance. As a fundamental investor, I want to see tangible increases in revenue, bottom-line net-profit results, you know, crazy things like that.
But it warrants double-digit gains in the stock price when we get an increase in subscribers in the minuscule-profit-margin streaming business (13%, versus 45% for those old-fashioned DVDs), when analysts suggest that Amazon.com's (Nasdaq: AMZN ) Prime Service isn't really competition after all, and when less than half of Netflix subscribers are actually satisfied with their service? That's over the top.
Ignoring competitive threats, or at least forgetting about them after the initial announcements, is a dangerous game. Google's (Nasdaq: GOOG ) YouTube hiring of Hollywood-quality talent, or the partnership between Coinstar (Nasdaq: CSTR ) and Verizon (NYSE: VZ ) , shouldn't be brushed aside. The 10% drop in Netflix share price following the Verizon/Coinstar partnership announcement in mid-May seems to be all but forgotten.
Any stock that has a history of the wild fluctuations Netflix does should immediately flash a large, red light in your eyes. Virtually all companies, at one time or another, are affected by dramatic news, and near-term trading will reflect that.
But the rollercoaster ride Netflix shareholders willingly climb on, never knowing which way the wind will blow on a daily basis, is an unnecessary level of excitement long-term investors should avoid. Want to test your mettle? Try zip-lining over a canyon somewhere -- it's less volatile.
An online company with a sound business model, and an outstanding track record heading into the holiday season, is Amazon. Though some Netflix investors may discount Amazon's streaming business, that's just one business line we look at in our premium report. For a complete picture of upside potential, and the risks, associated with Amazon, click here.