Daily Gains Letter

Netflix Successful, but Expensive; How to Invest with Less Risk

By for Daily Gains Letter |

Invest in Overvalued StockThe third season of House of Cards will likely once again see a massive influx of new subscribers flow to Netflix, Inc. (NASDAQ/NFLX). The company is sizzling on the chart and is the “Best of Breed” in the video streaming market at this time. Netflix currently has about 57 million subscribers.

Having said that, my stock analysis shows that the top-heavy valuation will need to be fuelled by better top-line growth, especially from the international markets where Netflix is dominant. The company already offers its streaming service in about 50 countries, but it is aggressively aiming to expand into hundreds of countries.

Netflix Plans for Expansion

Netflix just announced it would be entering into the Cuban market, which I believe is still very raw, given the lack of communications infrastructure there. The view may be that as the country opens up its relationship with the United States, there will be improvements in its communications technology. With about 90 million potential Netflix subscribers in Cuba, the market is significant.

Of course, Netflix is also trying to do something many other U.S. media companies have failed to do so far, and that is to expand into the massive and highly lucrative Chinese media market. The problem is that Netflix will do it alone. Based on the extremely tough and regulated nature of content in China, it will not be an easy chore for the company. Just ask Google Inc. (NASDAQ/GOOG) and Yahoo! Inc. (NASDAQ/YHOO). My stock analysis suggests that any success in the Chinese market would be a bonus that could drive the valuation much higher.

Video Streaming Competition Comes Down to Content

The streaming market is all about content. Netflix spent about $9.5 billion on programming in 2014, and based on the metrics, the strategy has worked. Competing against the likes of Amazon.com, Inc. (NASDAQ/AMZN), Hulu, and HBO, Netflix needs to continue to spend on programming and hope its shows are well received by viewers in what will be a heated battle. Netflix is currently the market leader, and I believe it will likely continue to be as we move forward.

At the end of 2014, Netflix had 57.39 million members, comprising 39.11 million domestic subscribers and 18.27 million from international operations.

The membership metrics clearly suggest the potential is in the international market. As the world’s broadband speeds improve, so will the demand for streaming. As I said, if Netflix can somehow get its foot into China (which would likely be censored), it would be a major step. My feeling is that getting in is the key, and the company can deal with censorship as it moves along.

Netflix by the Numbers

The fourth quarter saw a massive 60% beat in the earnings-per-share (EPS) estimates. Revenues are estimated to expand 22.7% in 2015, followed by 21.5%, to $8.21 billion, in 2016, based on Thomson Financial estimates.

Now, while I like the prospects for Netflix going forward, the valuation is another story. I believe it is excessive at this time and consider this the type of stock that should only be considered on weakness.

Top Investment Strategy for Overvalued Stocks Like Netflix

An alternative investment strategy for a stock like Netflix would be to sell put options at a lower strike price to generate premium income and set a lower buying price.

For illustrative purposes, consider a put option strategy on Netflix. Say you feel Netflix will decline over the next six months. You could sell the September $390.00 put option at around $16.70 per share, or $1,670 per contract. This means you would be required to buy the shares if they fall to $390.00 or below, well below the current $477.00 price. The risk is that any price below the breakeven at around $373.30 would mean a loss.

Netflix Chart

Chart courtesy of www.StockCharts.com

The key with writing put options is to decide a price with which you are comfortable and at which you are willing to buy the stock. For a stock like Netflix, this is a reasonable and lower-risk investment strategy investors may consider.

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