The Netflix No One Sees

Going over the latest quarterly report from DVD-rental specialist Netflix (NASDAQ:NFLX), one doesn't need long to spot the flaws. The company posted $0.08 a share in earnings for its fourth quarter -- twice as much as it generated a year earlier -- but now Netflix is on its way to posting a loss in the current quarter, thanks to a $4 monthly price cut that Netflix gave its subscribers for November in its cutthroat pricing war against Blockbuster (NYSE:BBI). With subscriber acquisition costs rising over the past year, lower monthly membership dues squeezed margins from both ends.

Free cash flow, though on the positive side, also clocked in lower. So why did the stock head higher last night? Well, for starters, Netflix customers are proving to be a loyal lot, with just a 4.4% monthly churn rate during the quarter -- the lowest defection rate in company history.

The market was no doubt relieved as well to learn that Netflix was able to grow its subscriber base from 2.2 million to 2.6 million members over the holiday quarter, despite Blockbuster's full-on assault and the threat of having Amazon (NASDAQ:AMZN) enter the domestic flick-rental business.

There was also a glimmer of long-term optimism. Sure, the company expects to post a loss between $16 million and $19 million in the current quarter. That translates into a loss of $0.25 to $0.30 a share. Yet by also guiding investors to expect the entire year's loss to fall between $5 million and $15 million, Netflix is targeting a profit over the balance of 2005.

Netflix is looking to close out the year with roughly 4 million subscribers. With nearly $3 a share in cash, the company certainly doesn't lack the funds to go full-throttle in marketing its service to reach those numbers, especially if that's what it takes to keep Blockbuster in check, Amazon on the sidelines, and Wal-Mart (NYSE:WMT) all but forgotten.

This doesn't mean that one should back up the truck and load up on Netflix. A business model of mailing out rented DVDs isn't necessarily tantalizing while its major players are locked in a price war. Yet if Netflix's aim is true, investors would find it hard not to like a company that will be back in the black in the year's final quarters, with a massive subscriber base that can become lucrative in so many ways beyond discs in red mailers.

Do you think Netflix will meet its targets? What would you do to keep your market lead if you were Netflix? All this and more -- in the Netflix discussion board. Only on Fool.com.

Longtime Fool contributor Rick Munarriz has been a Netflix subscriber -- and investor -- since 2002. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.