Source: Netflix
Netflix (NFLX 0.73%) has been one of the great stocks of the past decade and is a widely held and popular stock. When I was first exposed to the name and purchased some shares around the middle of 2007, I had no idea about the journey this stock would take me on.
I've become a much better investor in the years since and think that Netflix has a brighter future now than it did in 2007. We almost certainly won't see another 40-times higher move, but the downside risk of being completely destroyed by a larger competitor is significantly smaller as well. The company's plan for international expansion and increased domestic household penetration are on target, and I look forward to what the next decade has in store for shareholders.
Here are three things I've learned from my time as a Netflix shareholder.
"Locking in gains" is a meaningless buzz-phrase
When my shares first doubled, I sold over 20% of my holdings. I felt great and couldn't believe making a 100% return had been so "easy." When you "lock in gains," the next step, of course, is figuring out where those gains need to go next. Had I been looking to purchase a home, finance a child's education, or whatever goal I might have deemed important at the time, then selling would have made sense. But I was 22 years old, in my first year of law school, and not using the funds for any such purpose.
I don't remember what I invested in with the proceeds, but it certainly hasn't come close to matching Netflix's performance since. Terms like "locking in gains" and "playing with the house's money" cause more harm than good to individual investors. The moment money is in your brokerage account, or in your chip stack at a blackjack table, it is your money. Selling a portion just to cover your cost basis is a lazy heuristic that I have certainly used in the past and try to avoid now.
Selling because you believe the thesis is broken, because you have a better place for the funds, or because you want to pay for something that you value more than future proceeds from the stock are all valid. Selling in a mechanical way to "play with the house's money" is a sign that you don't feel comfortable enough with the underlying business to make a decision to hold, sell, or buy more on the merits.
Going from $300 to $55 hurts ... a lot
Netflix was rocketing higher and higher nearly every day until it began a six-month descent in the middle of 2011, where it lost over 80% of its value. The share price declined by about a third amid concerns over valuation, future content obligations, and many of the same arguments bears make about the company today. This type of drop is to be expected at times with hyper-growth stocks like Netflix.
In September of 2011 a public relations blunder, where the company announced that it was splitting into Netflix, which would focus on streaming video, and Qwikster, which would focus on the legacy DVD by mail business, further sent the stock price tumbling. After rebounding slightly and then dropping again the price hit a low of around $55 in September 2012.
I remember the panic about the future of the company and give myself a B- grade for my performance at the time. While I held onto all of my shares, I still didn't have a strong enough understanding of the fundamentals to realize that this was a tremendous buying opportunity. The stock's performance since that low has been nothing short of extraordinary.
While some made a fortune buying at these lows and others made the costly mistake of selling out near the bottom, I held on tight and rode out the ensuing few years. As the stock began recovering, I remember hearing about rumors of a buyout from one of the large tech companies and thinking how nice that would be. "If Apple or Microsoft would pick this up at $150, I could reinvest the funds into another idea." Of course, the company wasn't purchased and eventually blew past $150. Then I thought to myself, "Wouldn't it be great to get back to $300? I would love to sell out there for a nice premium." You all know where this story goes as the company was never bought and now trades for over $850 split adjusted.
My mistake here was the same that plagued me with the too-early sell: I wanted the decision to be taken out of my hands. This stemmed from insecurity about my ability to gauge where the company and not the stock price was headed. I'm glad Netflix wasn't acquired and that I held onto my shares as I don't think I would have learned this lesson had it been.
Best way I know to see tremendous gains
Holding onto great companies like Netflix, following the business, and adding to your position over time is the only way I know to see truly life-changing investment returns. I'm sure there are Fools out there who now have a cost basis in Netflix under $1 per share. Even now, for those who may be sitting on a greater than 100 times return, I still think the company has many wonderful years ahead of it.
Netflix will continue to invest in growth into international markets while continuing to generate more subscribers in the United States and Canada. At this stage, subscriber growth is the most important metric. Eventually, if all goes according to plan, growth will dry up and Netflix will become a mature company. At that time, I expect the revenue that had previously been used to fund expansion to drop to the bottom line, where it can be used for share repurchases, dividends, or acquisitions.
Ownership of a company like Netflix throughout this life cycle really shows the power of investing in creating wealth. Imagine if you had invested $500 in Netflix stock a decade ago at around $2.40 per share. Those 208 shares would now be worth around $25,000, assuming, of course, you never chose to "lock in gains," pay taxes, and deploy the funds somewhere else.
Now, if we ratchet down future growth expectations and the stock price doubles over the next six years, for about a 12% CAGR, we can see where the real magic happens. At this point, the stock price would be trading at around $240 per share. Assuming the introduction of a modest 2% dividend, your annual payout from the company would be around $1,000, or double your total initial investment. This could be achieved while deferring all capital gains taxes and with no additional work on your part.
Charlie Munger, one of the world's great investors, has said, "Investing is where you find a few great companies and then sit on your ass." Finding the great companies is difficult, but I've learned that the second part of the equation can be even more daunting.
