Last week a friend called to ask me what I thought of Netflix, the video service that’s fast evolving from a DVD-by-mail upstart to the dominant streaming site for television shows and movies. The reason for his call: Netflix has seen its share price sliced in half since the beginning of 2011 and on Oct. 25, after telling analysts that it had lost subscribers in the U.S., Netflix lost 35% in a single trading session. Chalk it up to expectations, because not much about Netflix’s business had changed except for a small hike in the price of a subscription, which led 800,000 people to cancel.
My friend had invested earlier and wanted to know whether the huge drop was a buying opportunity or a reason to panic and sell. Here’s what I think of Netflix, I told him: their streaming service is worth far more than the $9 a month they currently charge. I’d pay five or six times that to get access to everything from Mad Men to a Buster Keaton silent classic (“The General”) I stumbled onto recently. Compare that to the expense ($100 a month or more), lack of variety and wretched service of cable. And yet for all Netflix’s popularity (23 million subscribers), there isn’t much in the way of competition: Blockbuster’s DVD-by-mail business, Hulu+ for TV shows and, most significantly, Amazon’s hesitant steps into streaming. I’d be surprised if Netflix doesn’t sign up tens of millions of new customers in the next few years.
“But what do you think about the stock?” says my friend, who shares my enthusiasm for the product and for the stock market. That’s where investing gets complicated, I said. Even if I’m right about Netflix’s bright corporate future, I’d still need to know what Netflix is worth and compare that to the current market value. I’d need to be willing to stake a lot of money on that finding to make it worth the time and effort of researching the stock and then be prepared to watch the stock price whipsaw back and forth, because this is a company that speculators have piled into and out of. Netflix has an adversarial relationship with its suppliers—the Hollywood studios that own the rights and are desperate to avoid the fate of record companies—and no one knows how prevalent online streaming will become (Netflix has said its future is streaming, not DVD-by-mail).
How difficult is it to value Netflix? Trickier than it sounds because Netflix is a fast-growing company that is willing to spend heavily on the rights for TV shows and movies to lure new customers. On some measures—price-to-earnings, for example—Netflix shares look cheap. On others—price-to-book is one—it’s too hot to touch. If you use conservative estimates, the stock looks dramatically undervalued (by about 250% in my reckoning). If you use aggressive ones, dramatically overvalued (by about 100%).
That’s the cost of uncertainty: you think Netflix is a good buy, be prepared to commit significant funds, to monitor your investment for changes in the underlying business and to ignore another sickening slump in the stock price while you wait for your insight to pay off. Or you can grab the bargain that’s a sure thing: cancel your cable, send Netflix $9 for all-you-can-eat movies and TV and stick the monthly difference in a low-cost index fund. You’ll be richer, less anxious about the market’s every move, and more appreciatiative of the great Buster Keaton.
Post-script: The friend is sticking with his initial NFLX investment and hoping the stock rebounds soon.
Exchange-traded funds (also known as ETFs) are pools of investor money linked to sectors of a stock, commodity, bond, or other financial market. What makes ETFs unique is that they are divided into shares which can be traded on exchanges in units similar to stocks throughout the day.