Time for some tough love, tiger.
If you bought Netflix
You willfully paid 137 times trailing free cash flow (and 100 times earnings) for a business. No one made you do that. Reed Hastings certainly didn't. That was an unforced error, to borrow a phrase from Warren Buffett and the tennis court.
With that kind of multiple, you're just begging for the ghost of Ben Graham to come and haunt your portfolio (I hear he's more of a morning poltergeist). There is no margin of safety at that price tag: If the future ain't as rosy as you predict, or your fellow investors simply lose faith -- as was the case with Netflix -- you risk a permanent loss of capital. Netflix certainly hasn't been unique in this regard lately: OpenTable, Green Mountain Coffee Roasters, and Tempur-Pedic have all suffered at the hands of overvaluation.
And who can forget the dot-com bubble? Oh, yeah, that would be the expert Wall Street analysts who pumped these babies to the moon.
It's worth noting that if you didn't pay an insane multiple for Netflix, then chances are you're sitting pretty even at $85 a share. The lesson here is that valuation can never be ignored wholesale. I'm looking at you, Amazon.com
Reed Hastings' fault?
It's the job of the CEO to grow the fundamentals; it's the job of Wall Street and investors to price them. The failure here was with the latter group, not the former. Reed Hastings didn't mark the stock up to 100 times earnings; euphoric investors did.
What Hastings is responsible for is Netflix's operating performance, and that has been absolutely terrific.
Revenue has grown by 26% per year, on average, over the past five years. The story is the same for EPS (at 42%) and net income (at 36%). Return on invested capital has consistently been in the 15% to 30% range. That's even better than Amazon in all respects besides revenue growth.
As for investors, Netflix's stock is still up more than 320% since this time in 2007. That's light-years better than the S&P 500, and it's superior even to Amazon's amazing 190% blitz.
So if the stock hadn't made a brief detour to $300 but instead had a smooth ride $85, no one would be complaining about performance and Hastings would still be praised as a genius. Think about that. It hardly seems fair to judge Hastings differently for arriving at the same destination.
But if Wall Street and the media insist on doing so, then they should actually be praising Hastings. That's because his stock generously offered many years of future earnings and business returns -- in advance! -- back in July 2011. Pity, then, that more analysts and investors didn't recognize the "offer."
And the much-ballyhooed price increase -- the straw that broke the overvalued camel's back -- has turned out to be much ado about nothing. The company has more subscribers now that than it did before the price increase. Most any business that raised prices by 60% would go belly-up, but not Reed Hastings' Netflix. (Yes, that no doubt hurt its subscriber growth rate, but things appear to have normalized.)
Netflix has serious challenges in its future, such as contract negotiations with powerful studios, but it's clear that Hastings' leadership isn't one of them. To get the scoop on one company that could potentially dethrone Netflix in streaming -- that being Apple -- check out the Fool's new premium research report on the iEverything powerhouse.
Fool contributor Chris Baines is a value investor. Follow him on Twitter, where he goes by @askchrisbaines. Chris' stock picks and pans have outperformed 96% of players on CAPS. He owns no shares of the companies mentioned. The Motley Fool owns shares of OpenTable, Tempur-Pedic, Amazon.com, Netflix, Apple, and Green Mountain Coffee Roasters. Motley Fool newsletter services have recommended buying shares of Netflix, OpenTable, Apple, Amazon.com, and Green Mountain Coffee Roasters, creating a bull call spread position in Apple, and creating a lurking gator position in Green Mountain Coffee Roasters. 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.