Why I'm taking a pass on buying Netflix on the dip

Benj Gallander, Ben Stadelmann, and Philip MacKellar
July 27, 2022

Is Netflix Inc. a contrary stock yet? The streaming giant has had a terrible year and is down around 70 per cent from its peak in late 2021. The pandemic trade that sent names such as Netflix, Peloton Interactive Inc. and Zoom Video Communications Inc. skyrocketing has unwound, and inflation is hitting growth and tech stocks hard. This change in fortunes has landed Netflix squarely on my watch list, which is generally characterized by companies that have fallen on tough times. It has hundreds of corporations on it though, so making the list does not suggest an imminent buy or even a keen interest. Nevertheless, Netflix is intriguing, with many positive and negative factors to consider.

Regarding positives, the stock (NFLX-Q) has fallen a lot from its all-time highs, but has stabilized over the past three months. Though being rangebound is not much to write home about, it is a good sign, and sure beats having an investment candidate in free fall. The valuations are also materially better than they used to be. The price-to-sales, price-to-book and price-to-earnings ratios are all at or near multiyear lows.

As for recent earnings, the company’s second-quarter results were generally better than anticipated. The all-important subscriber losses were expected to total around two million, but instead the streamer lost “only” 970,000 paying members. Moreover, earnings came in above analyst estimates and while revenues missed the mark, the top line is still growing. Next quarter’s sales outlook is strong as well and management forecasts 12 per cent year-on-year growth (in constant currency). Finally, Netflix continues to produce great content, such as Stranger Things, Resident Evil and Inventing Anna. This is not to suggest Amazon, Disney+ and HBO (owned by Warner Bros. Discovery) are not also competitive content creators, but there is no shortage of attractive material on Netflix.

As far as negatives go, the guidance calls for operating profit and net income to drop in the next quarter. The organization is still losing a lot of subscribers and it will be hard to turn that around. Management thinks they will be able to, soon, and are strategizing how to do that but turnarounds are difficult and often take much longer to implement than expected. This may explain why the analyst community has turned sour on the name. Prior to April, Netflix had been rated a buy by Wall Street analysts for years. Today, however, most analysts rate it as a hold. A hold rating does not signal much confidence in the enterprise; analysts are sometimes reluctant to label companies a sell, so hold is often interpreted as a vote of no or low confidence.

Perhaps the biggest negative, though, is the valuation. While the metrics look better than they have historically, the stock is still pricey compared with peers, including Walt Disney Co., Warner Bros. Discovery, Spotify Technology SA and even Amazon.com Inc. The valuations are also much higher than that of the overall market. If inflation and interest rates move higher still, or the turnaround plans take longer than envisioned, the valuations could move materially lower from here.

Behind the scenes, since the stock price has wilted, almost no insider buying has occurred; prior to the downdraft, insiders were aggressive sellers. The top brass and the board of directors are often the best informed about the corporation’s prospects. This means insider buying or selling is usually a good indication of what is going on. This raises the obvious question – if Netflix is a great value today, why aren’t insiders buying? My interest in the stock will increase significantly if or when the executives and board start purchasing shares. As the old saying goes, there may be many reasons to sell, but there is only one reason to buy.

So, there you have it – Netflix in a nutshell. While there are strong arguments for taking a good look or even buying the shares today, there are still many negatives to consider. From this angle, I will wait to see how the strategy unfolds, keep an eye on the valuations and watch closely for insiders to start buying before getting more interested. Though the stock could rally without these conditions in place, in my book any such recovery would be somewhat too speculative for comfort.