4 Signs You're Betting on a Bad Stock

A startling number of Fools believe Netflix (Nasdaq: NFLX  ) founder and chief executive Reed Hastings should be fired. I'm not one of them. Neither is Fool co-founder Tom Gardner. But if you read the comments to a recent article I wrote about Hastings' leadership in the wake of an awful third-quarter performance and even worse Q4 guidance, I'm forced to question my own assumptions.

Thus the article you're reading now.

In more than a decade of investing, I've come to believe there are four things that make for a top-notch steward of shareholder capital. Here's closer look at each of them. See how you think Hastings rates after reading, and please use the comments box to single out executives that you believe either lack or fully possess these traits.

1. Engagement.
Does the CEO actively reach and respond to investors and customers? Executives who recognize who the owners are (i.e., the shareholders) and who keep the doors open and lights on (i.e., customers) are always more likely to create value than their peers are, especially in a regulated environment where the playing field is supposed to be equal. (I'll grant that recent evidence suggests that it too often isn't.)

Hastings had a history as a terrific communicator in years past. But the man who so clearly debunked the importance of Netflix's failure to re-up a deal with Liberty Starz (Nasdaq: LSTZA  ) went missing when it came time to elucidate the need for a 60% price increase and a separate website and business for distributing DVDs by mail. Of all his recent failings, I see this one as Hastings' biggest.

Whom do you admire when it comes to engagement? Whom are you skeptical of? In years past I've admired Oracle (Nasdaq: ORCL  ) CEO Larry Ellison's bluntness, only to lose faith recently. I've come to distrust his comments because they either seem (a) co-opted, or (b) askew with existing data. (Skewering cloud computing while at the same time holding a big stake in NetSuite (NYSE: N  ) , for example.)

2. Transparency
Are the financial statements clear and complete? Do the CEO and management team speak frankly on conference calls? Hastings has always struck me as excellent in this regard. Even his recent apologies, though late, I find to be appropriately contrite and his promises to make good genuine.

I'll understand if this seems like the "duh!" test. Of course management should be forthright! Of course companies should issue clear and complete financial statements! But does this always happen? Um, no. You'll find all the evidence you need parked on Wall Street. Find someone with a sign. Strike up a conversation and count the number of times said protestor rightly refers to undeserved bailouts and the startling lack of jail time for executives who almost certainly deceived not only investors but also themselves and regulators.

Or if you want to save time, check out the list of current actions pursued by the Securities and Exchange Commission. Go ahead, click. I dare you.

3. Strategic vision
Do the CEO and other executives describe the plan to achieve profitable growth in a way that's understandable and reasonable? There's no other way to know what you're investing in, and what to expect in the years ahead. Investors who fail to understand the vision for the companies they're invested in are -- to put it bluntly -- buying blind. Nothing could be more dangerous.

Here, too, I think Hastings deserves some criticism. Although I don't believe he was intentionally misleading or unclear, he did such a poor job elucidating the vision for Netflix-Qwikster that smart investors can hardly be blamed for selling at the time of the announcement. What choice did they have, other than to trust that Hastings hadn't completely lost his mind?

Strategic vision is easy to confuse with great PR skill or false hope spelled out in hyperbolic quotes in puffy press releases. It is none of these things. Instead, it is the je ne sais quoi that the late Steve Jobs brought to the stage in announcing new Apple (Nasdaq: AAPL  ) gear, and what shareholders will miss most now that he's gone. (No pressure there, eh, Tim Cook?)

4. Evidence
The silver bullet. When good leaders lead well, numbers follow. It's really that simple.

For most of Hastings' reign as Netflix CEO, there's been a bounty of great numbers. Revenue growth, margin expansion, subscriber growth, increasing returns on capital. Most of it went missing in Q3, but a quarter also doesn't make for a track record. Those of us who own shares will have to wait to see how Netflix performs in the New Year to fully judge the impact of a 60% price increase and any attempts to win back subscribers who've fled to Amazon.com (Nasdaq: AMZN  ) , Hulu, or DISH Network (Nasdaq: DISH  ) . There's nothing more we can do right now.

If there's a lesson I take from all of the hubbub -- and the apparent uprising against Hastings among common shareholders -- it's that management and good governance never stopped mattering even if I haven't been looking closely enough at the leaders I'm betting on in my portfolio.

Now it's your turn at the podium. How do you rate Hastings and the other leaders atop the companies you own? Please weigh in using the comments box below. Or if you'd prefer to lessen your dependence on great leaders while also boosting your returns, I recommend The Motley Fool's new special report on 11 top-performing dividend stocks. Get your copy now -- it's 100% free.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He owned shares of Apple and Netflix at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Google+ or Twitter, where he goes by @milehighfool. You can also get his insights delivered directly to your RSS reader.

The Motley Fool owns shares of Oracle and Apple. Motley Fool newsletter services have recommended buying shares of Netflix, Amazon.com, and Apple and creating a bull call spread position in Apple. 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.


Read/Post Comments (6) | Recommend This Article (15)

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 30, 2011, at 5:30 PM, bobyk3 wrote:

    My prediction is Netflix will lose lot more subscribers.

    As mail-out is a separate business, Redbox is a bigger challenge now.

    As with streaming, Netflix library is shrinking. At least, thats what I feel when I login and my friends were saying the same.

  • Report this Comment On October 30, 2011, at 7:22 PM, antipolis wrote:

    Everyone has become such an expert on Netflix and Reed Hastings, post fall. Yet these "experts" never complained when the stock was hoovering at $300 a share. So what has happened between then and now? For one, the spineless have bailed. No one is left holding stock unless they just recently bought at bargain basement prices OR are holding on hoping to recoup their losses. In starker terms, those without the will to see beyond the negative postings and articles have gone off to greener pastures (good luck). But Neflix is not dead. As a subscriber (and stockholder), I have more than 200 films and documentaries in my queue I still haven't watched. And I watch an average of 5-6 films a week. Maybe because I'm older and appreciate a wider variety of films than a twenty-year-old who sees the Netflix glass half full because the latest special effects film isn't offered I appreciate what Reed Hastings offers me for $8 a month. Think of the bargain this is. In spite of the company's basic fundamentals, which are what they are given that it's an entertainment distribution corporation, I believe that the stock will rebound, and soon. Likely not at the stratospheric levels it did, but I'm hopeful that it will be selling at $145/share by early spring. Don't be surprised. This company is getting beat up unnecessarily by all the hindsight experts. Give this stock a little time to breathe. And watch. Before the year is over it will be up over $118/share, and by March, $145/share. Admit it. All the volatility has been sucked out of the stock. All that you're going to see going forward are prudent investors buying over the next 5-6 months a stock that has only one direction to go--and that's up. Seriously, what company is a real threat to Netflix? Remember, more than 23 million subscribers DID NOT DEFECT. Profits are up over 60%. Reed Hastings is no dummy. Right now he's spending 24/7 trying to turn this ship around. Not because he's done anything REALLY awful. He's got a lot at stake, and I believe he will make good on his company. He's a savvy negotiator and visionary. The worst thing that could happen is that Apple will go into partnership with him. Netflix is not the Titanic, as so many want to make it out to be because they lost value in their investment or because they think themselves smarter than the CEO that actually created and guided a company. If you haven't already, buy stock in this company now. If you've lost money on this stock quit complaining. It will turn around.

  • Report this Comment On October 31, 2011, at 11:22 AM, akakroke wrote:

    People these days always want something for nothing. Netflix is in the spotlight right now because of their price increase but the same holds true for Coinstar (CSTR) because they raised the rental rate on DVD only (not blu-ray) .20 cents out of their RedBox units and people went ballistic, and also DISH (DISH).

    I mean give me a break! We've got it so good in this country and I wish customers, investors and analysts would just grow up.

    My Foolish 2 cents....

  • Report this Comment On October 31, 2011, at 11:30 AM, 0gers1 wrote:

    We found cable subscriptions relatively more expensive so we switched to Netflix years ago. Renting DVDs at kiosks was a waste of our time and gas money compared to the ease and convenience of a Netflix subscription.

    Recently, we tried to shop around again using Blockbuster (very slow mailing system), Amazon Prime (not enough choices), and Redbox (limited selection and time to return DVDs) to get the same 'Netflix effect'. Suffice to say, we were greatly disappointed and now realized how much we took for granted.

    To show our love, we added to our position and bought more stocks! We'll wait for Netflix to reciprocate. If Reed Hastings was CEO when the stock was 300+, I'm sure we won't be waiting for too long.

  • Report this Comment On October 31, 2011, at 12:39 PM, cattywampus wrote:

    The party is over, the kool-aid is all gone and our rebel hero hasn't lived up to our brew addled expectations. Looks like we loved another one to death. You can't be everything to everyone, the mistake is trying. Mr. Hastings is still a hero of mine. Welcome to the world stage and you thought we were a tough crowd. Luke, Peter, Bruce, Tony and the F4 have got your back, "it's clobberin time".

  • Report this Comment On October 31, 2011, at 12:42 PM, Bongwani wrote:

    For me, I think this whole argument around Netflix boils down to 2 things.

    1) Subscriber base - will it go up from here, or not? The share price will follow the movement in the subscriber base. There is still more than 20 million subscribers. Most people who wanted to leave have already left. I anticipate that some of the prodigal 800k are going to return to Netflix in the next few months. Many posts have talked of "serious competitors" but I have looked at a few of the competitors web sites (if they have one) and none compare to Netflix. In addition the competition is not significantly cheaper over the month. Netflix remains a better deal than cable, for me, and I have to assume that expansion into England is good. (Yes that is an assumption - and my assumptions are ALWAYS right, until they are wrong.)

    2) The conceited "captain of the ship" has had his ego spanked. I love it when the !% get spanked..... but I digress. In the short term I believe Reed will behave more humbly, and want to repair the damage he has caused, not multiply it.

    So I conclude therefore that the probable benefit to buying Netflix at its current price is greater than not owning it. I do not own any Netflix, but I am considering buying a LEAP.

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