Throw This Stock Away

I've been tossing out stocks every week this summer. Portfolios can always use a little pruning, so why wait for spring cleaning?

I'm doing more than just aiming for the trash can, though. I always offer up three worthy substitutes to replace the stock that I've soured on.

This week, I've decided to do something a little different. I'm going with a stock that I own. Yes, I have actually been a shareholder of this company since shortly after its 2002 IPO, but I believe that playing devil's advocate is a healthy thing to do with your investments. Since no stock is ever perfect, let's see whether I can poke any holes in one of my own longtime holdings.

So, who gets thrown out this week? Come on down, Netflix (NASDAQ:NFLX).

The typo so nice, they had to bungle it twice
Until last year, there wasn't a whole lot of "net" and even less "flix" in the company's model. Netflix has always been cozy with the Internet as a slick interface to queue up flicks and serve up recommendations, but it is -- in its purest form -- a DVD rental mail-order service.

This setup changed, of course, when the company began rolling out its Watch Instantly service, through which subscribers could stream select titles through their PCs at no additional cost. The service was slow to take off, but it's popular now that Netflix is using everything from Roku boxes to LG electronics to Microsoft's (NASDAQ:MSFT) Xbox 360s to deliver films directly into living rooms.

For now, at least, the library is limited to mostly indie films and obscure older titles, because major studios would never devalue their new releases without hefty revenue-sharing royalties in return. In fact, just 10% of the company's titles are available for streaming. In other words, the Netflix service can't really compete with the premium digital alternatives or your cable provider's video-on-demand offerings. You can rest easy, Comcast (NASDAQ:CMCSA).

Netflix also absorbs the hit on the chunky bandwidth. The company views it as a loss leader. But that isn't the only reason margins will be challenged in the future. Postal rates keep climbing, and the soft economy is keeping penny-pinching consumers at home. Yes, that's good for subscriber retention, but homebodies will rent more DVDs in any given month. And more orders will cost Netflix more in postage and in revenue-sharing with the studios.

Can Netflix rise above that problem? Last week's quarterly report was pretty telling. The number of subscribers rose by 25%, but revenue climbed by just 11% and net income inched only 4% higher. A lot of the deterioration on the way down was the result of a price cut last year to keep Blockbuster (NYSE:BBI) away. That strategy worked, but now consumers may not be receptive to a price increase.  

Netflix is looking to close out the year with as many as 9.7 million members and to come in squarely profitable, with between $1.19 and $1.31 a share in earnings. However, the future will be challenging to both the optical disc as a medium and the company's ability to compete in the cutthroat realm of digital delivery.

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.

• Apple (NASDAQ:AAPL): Apple TV was a rare miss in the Cupertino company's product line, but it's certain that Apple will still play a major role in the digital delivery of celluloid. The company's iTunes store is a leader in selling video downloads, and the convergence of computing and home theater won't be complete until Apple has a say in the future. 
• Bidz.com (NASDAQ:BIDZ): The online jewelry auctioneer has little in common with Netflix, but it makes the cut this week because of the similar way it butchers its name with a deliberate hipster typo. Bidz is growing a lot more rapidly than Netflix is, and it's selling at just 17-18 times this year's recently reaffirmed earnings guidance. Netflix is priced at a more expensive 22-24 times this year's profit target.
• Amazon.com (NASDAQ:AMZN): Amazon sells a ton of DVDs in its online store, but it's now a major seller in digital downloads, rentals, and streams of films and television shows. Amazon shares aren't cheap, but it has earned its premium with accelerating growth and promising initiatives to replace all three of its original media categories -- DVDs, CDs, and books -- with higher-margin digital alternatives. 

Invest carefully, and don't forget to separate your trashed stocks from the ones that can be recycled.

Other headlines out of the weekly garbage:

• This Is Why I Threw Your Stock Away
• Throw This Stock Away: Microsoft
• Throw This Stock Away: eBay