Netflix Shares Are Too Rich for Anything But a Long-Term Hold

If your time horizon isn't measured in years, steer clear of Netflix shares.

Jan 15, 2014 at 7:00PM

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Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Investors took heart as the House of Representatives approved a $1.1 trillion spending bill without all the drama and rancor we had become accustomed to. That was reason enough to push stocks to a new record high -- by a mere two hundredths of a point -- as the S&P 500 gained 0.52% on Monday. The narrower Dow Jones Industrial Average (DJINDICES:^DJI) was up 0.66%.

Call it mean reversion or call it a change in sentiment; either way, the trajectory of Netflix's (NASDAQ:NFLX) stock appears to be broken. In 2013, the streaming video provider was the best-performing stock in the S&P 500, with shares quadrupling; however, it has gotten off to a rocky start this year, and today was no exception, as the shares fell 2.2% (the orange line represents the S&P 500):

NFLX Chart

NFLX data by YCharts

First, Nomura Equity Research initiated coverage of Netflix with a "neutral" rating (or "hold" in plain English) and a $360 price target. In his note, analyst Anthony DiClemente writes:

We believe Street models already forecast healthy expectations for subscriber growth; while we are positive on original content and cable box integration, we do not believe these are material subscriber acquisition channels.

DiClemente's thesis appears to be that, given the reach it has now achieved in the U.S. -- Netflix surpassed HBO in terms of U.S. subscribers last year -- it should no longer to be considered as fundamentally different from competitors HBO or Showtime. Despite that, he believes Netflix is valued at a massive premium to those peers:

An important question: Is Netflix valued appropriately? The market currently believes Netflix is worth 50–60% more than HBO (within TWX) and more than double Showtime (within CBS). As a multiple, we believe most investors value HBO at a 2015E EV/EBITDA of 9–10x, whereas Netflix trades at roughly double that multiple.

Perhaps the explanation for that discrepancy can be found in another analyst report published today, this one from MKM Partners. Analyst Rob Sanderson maintained his "buy" rating on the stock, but raised his price target from $370 to $440. Netflix remains one of his top picks for 2014 on the basis of its growth prospects globally:

We think NFLX is in by far the best position to grow a very large, global subscription business in this emerging opportunity. The company has the lion's share of know-how, scale advantages over other OTT providers and the most actual data on viewing behavior of any provider of video services across any platform. The base of roughly 40mn paying subscribers globally is just the beginning. We think this business will scale to 150-175mn global subscribers over time.

In other words, DiClemente may be right that the shares look a bit pricey -- if one is reasoning on the basis of expectations for the next 12 months. However, if one takes a longer-term view, over the next three to five years, say, that concern may prove overblown -- assuming Netflix is able to capitalize on the global growth opportunity Sanderson highlights.

Netflix is a remarkable business, but buying the stock at current its current valuation assumes one has an ultra-long time horizon (by today's standards, anyway -- I mean something on the order of five years or longer). Otherwise, as I wrote on Jan. 7, "if ... you're just getting into the shares now, hoping that last year's momentum will persist in 2014, you may want to re-examine your goal and your assumptions."

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Fool contributor Alex Dumortier, CFA, has no position in any stocks mentioned; you can follow him on Twitter: @longrunreturns. The Motley Fool recommends and owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.

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