Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Netflix (NFLX 4.17%) dropped its Q2 earnings news last night, and then its stock dropped, too -- down 14% after hours. Right now, all the talk is about how Netflix fell more than 1 million subscribers short of its public goal of adding 6.2 million new subscribers in Q2. Just days before earnings came out, The Wall Street Journal (subscription required) confidently proclaimed "it is hard to believe it won't" hit its target.
And yet, Netflix did miss its target, sparking today's sell-off. Is it time to panic now?
Here's what Wall Street is saying.
Image source: Getty Images.
The skeptics
Wall Street is scrambling to come to grips with Netflix's results this morning, with StreetInsider.com (subscription required) reporting more than a dozen changes in price target already, as well as one full-fledged downgrade (but also two upgrades, as we'll see in a moment).
So far, nine analysts have lowered their price targets on Netflix.
Monness, Crespi, Hardt called the quarter "softer-than-expected" and predicted the stock "will finally get a correction" after more than doubling year to date. Regardless, Monness expressed confidence in Netflix's "strong, global, secular growth story," and cut its price target only to $430 per share -- implying a quick bounce back from today's fall.
Merrill Lynch likewise believes Netflix is worth more than investors are giving it credit for today, cutting its price target only to $410 per share. Merrill is encouraged by the fact that Netflix kept its operating profit margin from falling below 11.8% (a 30-basis-point sequential decline).
UBS is more concerned, calling last night's subscriber miss "a clear break from recent business model momentum" and cutting its price target to $360. (But even UBS thinks Netflix will return to "sustained topline growth & forward margin expansion" going forward.)
In contrast, Goldman Sachs, possibly the most optimistic of the bunch, cut its price target only to $470, believing that "the impact to investor expectations for LT subscriber growth should be negligible."
Analysts at Buckingham Research, Loop Capital, KeyBanc, Canaccord Genuity, and Credit Suisse cut their price targets to anywhere from $305 to $470.
The downgrader
Among bankers who've actually downgraded Netflix's stock in response to earnings, Deutsche Bank cut its rating from buy to hold -- but perhaps only temporarily. Deutsche's new price target is among the lowest on Wall Street -- $350 -- and the analyst does not "see much upside over the next 12 months at this valuation level." However, Deutsche believes that by 2025, Netflix shares will be selling for twice its price target and argues that the stock is fairly priced at 10 times annual sales.
Optimists and upgraders
Perhaps even more interesting than the skeptics and critics, however, are the optimistic reactions from a handful of analysts on Wall Street.
For example, BMO Capital Markets argues that India and Japan will be "growth stories" for Netflix, as will Japan, as we move through 2018 and "into 2019." And while some content providers may tighten the spigot on Netflix's outside-sourced content, BMO believes Netflix is well-positioned "to continue to transition to more originals from licensed studio content." All things considered, BMO finds Netflix likely to outperform the market from today's price, and sets a target of $400 on Netflix stock.
Price is the object for Stifel Nicolaus as well. Believing the shares are worth $406, this analyst upgrades Netflix to buy largely because the sell-off has now created room for upside as Netflix approaches that target. Thanks to yesterday's miss, investors can expect Wall Street to "reset" its expectations for subscriber growth, giving Netflix more of a chance to beat those expectations as it doubles its subscriber base over "the coming 5 to 10 years."
Indeed, in Bernstein's view, today is "the day NFLX investors have been waiting for." The analyst says, "Everybody knew the day would someday come when Netflix would fall short of quarterly subscriber expectations" and the stock would go on sale. "Here is that day," advises Bernstein, urging investors to buy the stock and predicting Netflix will rebound to $434.
Wells Fargo makes the curious observation that "stronger cash flow" at Netflix is a reason to buy into today's sell-off. (Although in fact, Netflix reported $518 million in negative cash flow -- more than twice the burn rate reported in Q1, according to data from S&P Global Market Intelligence.)
One Fool.com contributor's view
And as for me, what do I think about Netflix's results? Believe it or not, I'm looking at the same number Wells Fargo is looking at -- albeit I come to a slightly different conclusion.
With $518 million in negative operating cash flow in Q2, and a further $27 million spent on capital investment, Netflix ended the quarter with negative free cash flow of $545 million, bringing its total cash burn for the past year to negative $1.8 billion -- and putting Netflix on a path to record its fifth straight year of burning cash.
For me, that's been reason enough to avoid owning Netflix. Other investors, however, have proven more willing to forgive this growth-by-conflagration business model so long as Netflix was growing as fast as it promised to. But how will they react now that Netflix has stumbled?
I can't help but think investors' faith in the stock will fall as well. Sure, if Netflix turns around and beats on subscribers next quarter, Q2 can be passed off as a mere bump in the road. But the stakes for Q3 just got immeasurably higher. One more quarter of below-expectations subscriber growth, and we could be looking at a trend -- and a Netflix sell-off that will put today's sell-off to shame.
