Time to Turn Cautious on Netflix Stock as Company Announces Earnings

Will Healy

Netflix (NASDAQ:NFLX) reports its second-quarter earnings on Wednesday after the bell. Since the last report, investors now have more insight as to the competitive situation currently faced by holders of NFLX stock.

The move by Disney (NYSE:DIS) to take full control of Hulu leaves Netflix with a competitor on more fronts. Moreover, a new attitude toward content development shows increasing caution.

Netflix stock

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For now, this has had little effect on NFLX stock as it trades near all-time highs. Still, with the competitive landscape changing for the worse, one has to wonder if NFLX can continue to achieve new highs.

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Given this uncertainty, investors should consider staying out of Netflix stock going into earnings.

Watch for Both Earnings and Guidance

Wall Street predicts the video streaming service will report earnings of 56 cents per share. If this number holds, it will represent a 34% decline from the same quarter last year. NFLX earned 85 cents per share in the second quarter of 2018. However, investors need to know that one-time charges affected profits in this quarter. For revenues, analysts forecast an increase of 26.3%, assuming that number meets the predicted $4.93 billion. The company brought in $3.91 billion in the same quarter last year.

However, investors should also pay attention to forward guidance, primarily because its business environment will quickly become more competitive. As a result, events seem to signal retrenchment at Netflix. The company will soon lose content from Disney as Disney+ launches on November 12. With Hulu, the competition from Disney will now affect Netflix with both child and adult-oriented programming.

Waning Euphoria Could Hurt Netflix Stock

Moreover, Netflix has decided to pull back on its own content development, or at least become more selective. From a financial point of view, one might see this as a positive for Netflix. This makes it less likely the company will fund more expensive flops. Understandably, the company wants to avoid repeating a $200 million mistake like “Marco Polo,” or the $115 million disappointment that was “Triple Frontier.”

However, the unbridled optimism helped to take Netflix stock to its trailing price-to-earnings (PE) ratio of 104. Analysts expect average annual earnings growth of 49% per year for the next five years. This has helped elevate the PE ratio. However, with less optimism to fuel a higher multiple, NFLX stock could easily see multiple compression as a result.

The dominance Netflix enjoyed in the streaming industry also influenced the multiple. The moves by Disney threaten that industry leadership. Also, Comcast (NASDAQ:CMCSA), Amazon (NASDAQ:AMZN), and AT&T’s (NYSE:T) WarnerMedia have rolled out appealing alternatives. Further, products such as the streaming box offered by Roku (NASDAQ:ROKU) allow viewers to easily switch between streaming services.

Also, the NFLX stock price may have reached an inflection point. NFLX recovered quickly from the December slump. However, it had twice pulled back when the price approached $400 per share. With the current price of around $365 per share, this could leave little room for growth.

The Bottom Line on NFLX Stock

Both the price action and the competitive developments in recent months could bode poorly for NFLX stock. For most of the decade, NFLX surged higher as it displaced both video stores and increasingly, cable and satellite TV to dominate the streaming industry.

Companies like Disney, Comcast, and AT&T have responded with alternative streaming services. Also, the increasingly cautious attitude on content development could help to kill the euphoria that drove NFLX stock to triple-digit PE ratios.

At Netflix’s current price, investors must also contend with the inability for NFLX stock to stay above $400 per share. Not only must the company beat earnings and revenue estimates, but it must also impress Wall Street by issuing more positive guidance. Given these conditions, investors may have to worry as much about beating multiple compression as they do about exceeding estimates.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

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