Netflix Needs Strong Growth

 | Dec 24, 2013 | 9:00 AM EST
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The best performing stock in the S&P 500 is Netflix (NFLX). Year-to-date the stock is up over 300%. Now what? With no-yield growth stocks leading the market in 2013, can Netflix continue to outperform when interest rates rise and investors change direction?

Netflix investors have had an incredible ride, especially for a company that owns virtually nothing. (Okay, they own a handful of TV shows.) Total membership expanded 33% to 40 million from 30 million as the company has aggressively invaded Latin America and Europe. Netflix operates in 41 countries.

At the end of October, Netflix reported better-than-expected third quarter revenues of $1.11 billion, up 22.2% year-over-year. The international business contributed to the upside in the quarter. Management projected fourth quarter subscriber growth would be flat, since last year's fourth quarter was so strong and the company is working through "low quality" Latin American free trials.

You have to keep pushing out your outlook to move the stock higher. Right now, investors seem focused on fiscal 2015, when Netflix is projected to have revenues over $6 billion. The consensus for 2013 expects revenues of $4.3 billion, up 20.9% year-over-year.

To get to the later years, Netflix must find more paying subscribers. And a lot of paying subscribers at that! Next year Netflix has to grow revenue 19% and 17% the year after. For comparison, don't forget the company only managed 13% growth in 2012.

Netflix has to increase its member base at least 20-25% to boost revenue in the mid-teens. That works out to something like another 10 million customers. I'm not saying it's impossible, but driving subscriber growth is getting harder every day.

Carl Icahn, when asked why he sold his block of Netflix shares, said: "As a hardened veteran of seven bear markets, I have learned that when you are lucky and/or smart enough to made a total return of 457% in only 14 months, it is time to take some chips off the table."

I agree with Carl. As the Federal Reserve begins to let interest rates rise, investors will turn their attention away from low-yielding high flyers. Coupled with the fact that growth gets harder everyday, I doubt Netflix will be one of the best performing stocks of 2014.

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volatility is quite low here, and we could see some downsides here in the short term. ...



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