After surging more than 60% after earnings last month, shares of Netflix (NASDAQ:NFLX) closed last week around $165. This week, shares have already gained an additional 12%, closing at $184.41 on Wednesday. What has caused this secondary rally?
Unfortunately for shareholders, the main cause of this week's rally has nothing to do with Netflix's fundamentals. Instead, it has primarily been driven by speculation that Netflix will take Dell's spot in the Nasdaq-100 index. Traders are probably buying Netflix now to take advantage of future capital inflows from portfolio managers who track the Nasdaq-100.
Re-entering the Nasdaq-100
The Nasdaq-100 index is made up of the 100 largest non-financial companies listed on the Nasdaq exchange. It is one of the most popular indexes in the stock market, and is tracked by the PowerShares QQQ ETF. Netflix had been a member of the index until it was removed late last year. However, with Nasdaq-100 member Dell having announced this week that it will go private through a leveraged buyout, the exchange needs a new member for the Nasdaq-100 index.
In the two months since it was dropped from the index, Netflix's stock has nearly doubled in value. That makes it currently the most valuable member of the Q50, a group of 50 stocks next eligible for inclusion in the Nasdaq-100. As a result, it is now the leading candidate to take Dell's spot in the index. Traders, expecting future inflows to Netflix stock, have jumped in now to profit from the change.
Fundamentals have not improved
However, if we look at Netflix's fundamentals, there is no reason for the stock to be logging significant gains this week. The company's flagship original series, House of Cards, was released last week, but Sandvine (a company that monitors Internet data usage) stated on Monday that Netflix saw no measurable increase in traffic since the release. Netflix is relying on House of Cards to drive subscriber growth, and spent $100 million to produce two seasons of the show. Unless Sandvine failed to adjust for the dampening effect of the Super Bowl on Netflix usage, this data point is ominous.
Furthermore, on Wednesday, USPS announced that it plans to eliminate Saturday mail service beginning in August. This will have a significant impact on Netflix's DVD-by-mail service. Customers will not be able to exchange their DVDs as frequently, which could lower the value of the service. By contrast, Coinstar's Redbox kiosks are available on weekends, so Redbox may become more attractive as an alternative for customers who want DVDs rather than streaming video. Netflix expects a contribution profit of more than $100 million from the DVD business this quarter, so losing more DVD customers will have a clear negative impact on profitability.
In the short run, if Netflix is added to the Nasdaq-100, it could give the stock a boost. However, here at the Fool, we focus on the long game. Netflix faces many long-term challenges, and long-term performance will determine the stock's trajectory over the next several years. The news this week suggests that Netflix's struggles are not over just yet.
Fool contributor Adam Levine-Weinberg is short shares of Netflix. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.