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I love Netflix (but not the stock)
Renting DVDs online might be the coolest thing since sliced bread. But 200 times earnings?
April 18, 2003: 8:48 AM EDT
By Paul R. La Monica, CNN/Money Senior Writer

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NEW YORK (CNN/Money) - I have a confession to make. I am a Netflix junkie.

I love the online DVD rental service. My fiancée and I get a kick out of adding movies to our ever-expanding queue. Do we want to have "Secretary" shipped first, or "Far From Heaven"? ("Far From Heaven" won out.)

And I am not alone. Netflix recently announced that it passed the 1 million subscriber mark. Not bad for a company that's only been in business since 1998 and didn't start its subscription service until Sept. 1999.

The allure of Netflix is simple: DVDs mailed to your home. Some would say it's more convenient than going to Blockbuster if you have a busy schedule. Others would argue that it's a prime example of sloth. Either way, for $19.95 a month, you can have as many as 3 DVDs out at any given time. And there are no late fees.

Once you send a DVD back (in a postage-paid envelope) and Netflix receives it, the next one on your list is mailed out. So if you watch a lot of movies, it's definitely cheaper to be a Netflix subscriber than pay $5 for a DVD rental at the video store.

More fluff than a bag of popcorn

Netflix reported its first quarter results on Thursday. The company posted a net loss of 20 cents a share and sales of $56 million, better than analysts' expectations. The company also raised its revenue guidance for the full year to a range of $255 million to $275 million. Analysts are predicting a profit of 11 cents a share for 2003.

The stock has been a rarity of the financial markets so far during these awful Aughts, a successful Internet IPO. The company went public at $15 a share last May and is up 45 percent since then. What's more, Netflix (NFLX: Research, Estimates) is up more than 300 percent since bottoming in early October, along with the rest of tech.

And that's the big problem. As much as I love Netflix as a company, I don't love it as a stock. Shares are trading at a sky-high, nosebleed valuation of 200 times 2003 earnings estimates. To be sure, earnings and sales are expected to surge dramatically in 2004. But even with the 2004 earnings estimate of 48 cents a share, the stock is still trading at a not exactly thrifty P/E of 45.

Also, even though Netflix is the leader in the online DVD area, it is certainly not immune from competition. Having the proverbial first-mover advantage is not a guarantee of future success.

Investors overlooking risks

Wal-Mart (WMT: Research, Estimates) now has its own subscription-based online DVD rental service. And it's a tad cheaper than Netflix, at $18.86 a month. Blockbuster (BBI: Research, Estimates) tested out a service called Filmcaddy.com last year and is said to be preparing a nationwide launch. Mail order music and video firm Columbia House, which is partially owned by AOL Time Warner, the parent of CNN/Money, is also looking to enter the online DVD market.

An even bigger threat for Netflix down the road could be video on demand services from cable companies.

To be sure, Netflix is pretty quick. I usually receive a new DVD two to three mailing days after I send one back. The company has 18 shipping centers nationwide and is aiming to be able to have 70 percent of its subscribers receive next day delivery by the end of the year. But it might be hard to compete against a service that allows you to watch a movie at the mere push of a button.

None of these concerns seem to be priced into Netflix's stock right now.

I hope I'm wrong

So far Netflix has quieted the doubters. Subscriber growth is healthy, despite a lousy economy. And as it adds more shipping centers, the service should get even better.

What's more, the company has avoided the cardinal sin that most dot-coms committed, wasting their IPO proceeds on expensive (and typically ineffective) ad campaigns. Netflix has widely relied on a low-key marketing strategy and a lot of word of mouth. To that end, I'm constantly harassing fellow DVD owners that aren't subscribers to sign up.

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I hope Netflix succeeds. But investing in something you personally like or think is cool may not always be smart, especially during that initial wave of euphoria. I just find it hard to believe the company can produce enough subscriber, revenue and earnings growth to justify the current multiple.

Just look at Amazon.com. It's another company that does a great job in e-commerce. Amazon's stock has done really well during the past year and the company is finally profitable. But shares are still 75 percent below their bubble-induced peak in late 1999.

Valuations do matter...even for a company that's cool.  Top of page




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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.