ProfyB (91.35)

Netflix

November 03, 2009 – Comments (1) | RELATED TICKERS: NFLX

Netflix was my very first investment.  I had bought shares of it in August 2007 for $18.  I bought more shares of it in September 2008 at $18.50.  I sold my entire position last March at $39.  Sounds like a nice profit right?  Too bad (for me) that the shares had reached $55 recently.  Was selling a mistake?  Did I sell correctly and the market is just bringing Netflix shares unreasonably high? 

A little bit of price history:  March 2009 was not the first time Netflix shares hit $40.  They were at that level in February 2008.  At the time Netflix's P/E was well over what it is now.  I should have sold, I didn't think Netflix could provide the growth that justified that P/E.  I didn't and the problem with high P/Es is that they're based on hope.  The slightest sign that that hope will not be achieved knocks shares down.  Netflix shares dropped 25% when their earnings didn't meet the sky high expectations.  I held onto my shares because the 25% drop put Netflix shares at reasonable valuation.  Now stock prices have nothing to do with the quality of the company, but they do have an effect on my wallet.  Despite my conviction of being a long term investor, I kicked myself for falling into the "long term" trap which is not selling when you should.

Now at the time, Netflix still seemed to have a good business model.  It's why I decided to buy more shares later on.  However, my confidence in their business model started to shake.  Despite the fantastic service (I'm a customer) and good management (they treat their employees fantastically and run on low debt), I worried about their ability to grow.  They have about 10 million subscribers which may seem like a good sign because they have a lot of customers.  However, they have no international presence and there are only 300 million people in the US.  10 million out of 300 million may seem like a small share, but keep in mind that a family can share one Netflix subscription.  The amount of competition also makes things difficult.  There's Hulu, Amazon, Apple, Walmart, Redbox, traditional Cable/Satellite TV and every TV station that offers their shows online.  

I also worry about Netflix's deal with the MPAA.  The MPAA is of a similar mindset as the RIAA and the RIAA has been attempting to squeeze and providers of music online (they recently tried to kill online radio stations).  I don't doubt there's a huge risk of the MPAA attempting to squeeze companies like Netflix.

Another worry is Netflix's deal with the post office.  The advent of the internet has crushed the post office's revenue.  Unions and government incompetence will force the post office to continue operating at a loss.  Closing unprofitable post offices is not going to happen so the post office will either need to raise prices or leech more money from the government.  In the latter case Netflix would be fine, but the former would be bad news for Netflix.

Now with all these risks, a P/E of 30 seems pretty high for Netflix.  Their growth in earnings may make it seem reasonable, but part performance is no guarantee of future performance.  High growth also makes it difficult to grow further due to saturation of markets and the inherent disadvantage of a large capital base.  It means that selling was a good idea.  Even though I missed out on some profits, I had no guarantee of knowing about those profits at the time.  The issue is, the real reason I sold was because I was afraid of seeing the stock drop 25% again.  I had plenty of valid reasons for selling, but in the end the deciding factor was stupid fear.  I may have made the right move in selling, I did so for the wrong reasons.  Hopefully, I'll learn from my mistake in the future.