“Hedge fund manager and founder Paul Tudor Jones once asserted that investors should only look for a stock where the technicals – a healthy share price chart – supported the fundamentals, such as profits and cash flow, so shareholders in Netflix have two reasons for concern, following the media services provider’s third-quarter results,” says Russ Mould, AJ Bell Investment Director.
“First, subscriber additions undershot estimates in Q3 and are now forecast by co-CEO and founder Reed Hastings to fall year-on-year in Q4 and the first half of 2021.
Source: Company accounts, management guidance for Q4 2020. Presentation of membership additions restated Q1 2020, backdated to Q1 2018.
“Second, the shares have had four goes at breaking the $550 mark in 2020 and they have failed each time. This is not to say this barrier will prove insurmountable forever – it took gold the thick end of six years to crack the $1,300-an-ounce mark and further rapid gains quickly followed once it finally did so in 2019 – but Netflix may need to provide better-than-expected subscriber growth if that apparent technical hurdle is to be overcome.
Source: Refinitiv data
“Bulls of the stock will point out that Netflix racked up record revenues, earnings per share (EPS) and operating cash flow in the third quarter.
Source: Company accounts
“But the problem is that EPS of $1.79 still undershot consensus forecasts of $2.13, while such progress has long since been discounted by the company’s $232 billion market cap, which compares to forecast full-year sales of $24.9 billion and forecast net profits of $2.7 billion. A forward price/earnings ratio of 86 times – compared to the S&P 500’s 22 times multiple, based on Factset research – leaves no margin for error at all, as it demands rapid earnings growth to justify such a valuation and upside surprises for share price gains.
“On this occasion, Netflix has failed to provide the upside surprise and the shares are likely to react accordingly.
“It is not in doubt that consumers have found its services incredibly helpful during the pandemic and lockdowns. But that does not mean that shareholders can pay any price to access its profits and cash flows and expect a positive return. It could well be that Netflix will continue to thrive, especially when content production returns to normal levels, although anything like a return to ‘normal’ could see an economic upturn that sees cyclical stocks generate even faster earnings growth as their profits pick up from deeply depressed levels.
“In such an environment, growth would not be as scarce as it is now. Investors would therefore be less inclined to pay a premium for companies like Netflix that have proved capable of providing it, even during a very difficult period for everyone, especially as cyclical growth would be available much more cheaply in so-called ‘value’ names whose shares have performed poorly.”
