Netflix’s Stock Rally Could Be Derailed In Short Run; 2 Risks To Watch

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Could video-streaming giant Netflix (NASDAQ:NFLX) be heading for a fall? It’s not unusual for high-flying tech companies to lose their momentum and stop showing the level of growth the markets have already priced in, often resulting in a nasty and unwelcome correction.

Netflix's Stock Rally Could Be Derailed In Short Run; 2 Risks To Watch

Facebook, Apple Weekly

The price charts of Facebook (NASDAQ:FB) and Apple (NASDAQ:AAPL), during 2018 provide a good example of this: Both stocks were down between 30%-50% from their mid-year record highs of the past 12 months. The factors that brought these tech giants to their knees were different, but the losses were quick and colossal in both cases.

Netflix’s fourth-quarter 2018 earnings report in mid-January suggests it may be the next in line to disappoint.

Netflix's Stock Rally Could Be Derailed In Short Run; 2 Risks To Watch

NFLX Weekly 2016-2019

Investors love Netflix stock for one primary reason: it continues to show impressive subscriber growth, the bottom-line number most analysts and investors focus on. Netflix shares have rallied 477% in the past five years, a reflection of the explosive demand for its cheap and easy-to-use service that now has 139 million subscribers worldwide.

Slowing U.S. Growth, Cash Burn

In the final quarter of last year, Netflix added nearly 9 million new paying subscribers and expects to add another 8.9 million subscribers in the quarter that ends in March. But beneath these forecasts, we see danger lurking: growth is plateauing in the streaming entertainment giant’s home market, from which it derives most of its revenue.

The internet giant expects to add 1.6 million new paying customers in the U.S. in Q1, down from 2.3 million it added in the same period a year ago. Investors are willing to ignore that deceleration in growth as long as Netflix shows overall growth and remains a strong brand globally.

But in markets, perception is the reality and it doesn’t take much to change that perception. The company’s latest move to raise its monthly prices for its over 60 million U.S. customers between $1 to $2 a month, also shows that Netflix isn’t betting big on the home front and plans to squeeze more dollars from the existing base.

Another potential red flag is that Netflix is pursuing a risky growth model based on borrowing from credit markets to fund new programming as well as its marketing budget. While reporting its Q4 numbers, Netflix disclosed that it expects to spend about $3 billion more than it takes in during 2019. This would make it the company’s sixth straight year of burning cash.

So far, Netflix debt-fueled growth has paid off. The company is producing highly acclaimed original films and series. According to CNN, Netflix’s “Roma,” has 10 Academy Award nominations this year and is widely considered the favorite to win the best picture Oscar.

Netflix stock, which closed yesterday at $356.87, has rebounded strongly from its December low, surging about 54% since the Christmas Eve slump.

But what if subscriber growth in its most lucrative market continues to slow and the company keeps burning more cash each year to cover the cost of its success? Investors would find it hard to ignore a mix of that sort, and the company’s stock price would, sooner or later, reflect that reality.

Bottom Line

Highlighting these risks doesn’t mean that we don’t like Netflix stock. In our view, it’s a great success story which has totally re-shaped the media entertainment industry.

The company will likely generate many more blowout quarters on the strength of its content, wide global appeal, and superior technology. However, long-term investors should be ready for short-term corrections when they invest in high growth stocks. After Facebook and Apple, Netflix might be the next to test their nerves.

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