Netflix (NFLX) Stock Is Going Down; Here’s Why

Investing in Netflix's (NFLX) stock presents a terrible risk-reward proposition with scary downside and dreadful upside potential, and as for its price, it is quite overvalued.AT&T (T) and Dinsey (DIS) are betting all-in on their respective streaming services. As they pull their content from Netflix, the appeal of keeping a Netflix subscription will drop, and the stock is likely to follow suit. The recent price increase demonstrates that Netflix has limited pricing power, and that will only get worse as the company losses further content and less expensive alternatives platforms emerge.How is the prediction going?Since February of last year, I have been using the mathematical model of how diseases spread in a population to predict how Netflix will grow its subscriber base. This behavior presents an S-Shaped graph.Source: APSThe Mathematical model predicted that Netflix would perform poorly in the U.S. market but firmly in the international market. While in the past the model had been very accurate, it failed to contemplate the effect that a price increase would have in Netflix´s ability to add subscribers.The results and guidance that Netflix showed were quite telling. First, Netflix Subscribers declined in the U.S. from Q1 to Q2, which could be a result of market saturation finally catching on, like the model predicts, or because of the increase in the subscription price.Source: Author´s Charts with Netflix InfoInternational performance was much lower than expected, which reflects that Netflix´s pricing power is not strong and price increases do have a significant impact on the number of subscribers the company can get.Source: Author´s Charts with Netflix InfoIf we compare predicted revenue to actual revenue, Netflix delivered a better result than expected.Usually, sacrificing market growth to obtain greater financial growth is not bad. It is a strategy that giants like Apple (AAPL) have done well. However, as Disney and AT&T will soon introduce their streaming service, the price increase could prove to be a bad long-term strategy.Source: Author´s ChartsNetflix is rolling out price increases in Europe, which could drag international subscription growth even lower. Hopefully, the company learned its lesson with the U.S. Market but, if not, Q3 will continue to disappoint.The chart above illustrates just how aggressive the price increases have been. Despite Netflix's intention to roll out a price increase of more than 10% this year, it will likely be offering less content than what is currently available.Disney´s strategy for its service will be to begin with a lower price tag to attract customers. People that have Amazon (AMZN) Prime Video might consider Disney´s less expensive option provides a better value.Compared to HBO, there will not be a big price difference. As AT&T pulls its content away from Netflix and into HBO, however, Netflix will have to prove that it can deliver the same quality service at a slightly lower price. Netflix will have a hard time offering sufficient popular content with Disney also pulling their content. While Netflix is investing heavily to create content, it will be competeting with the decades of content creation that...

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Investing in Netflix's (NFLX) stock presents a terrible risk-reward proposition with scary downside and dreadful upside potential, and as for its price, it is quite overvalued.” data-reactid=”11″>Investing in Netflix’s (NFLX) stock presents a terrible risk-reward proposition with scary downside and dreadful upside potential, and as for its price, it is quite overvalued.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="AT&T (T) and Dinsey (DIS) are betting all-in on their respective streaming services. As they pull their content from Netflix, the appeal of keeping a Netflix subscription will drop, and the stock is likely to follow suit. The recent price increase demonstrates that Netflix has limited pricing power, and that will only get worse as the company losses further content and less expensive alternatives platforms emerge.” data-reactid=”20″>AT&T (T) and Dinsey (DIS) are betting all-in on their respective streaming services. As they pull their content from Netflix, the appeal of keeping a Netflix subscription will drop, and the stock is likely to follow suit. The recent price increase demonstrates that Netflix has limited pricing power, and that will only get worse as the company losses further content and less expensive alternatives platforms emerge.

How is the prediction going?

Since February of last year, I have been using the mathematical model of how diseases spread in a population to predict how Netflix will grow its subscriber base. This behavior presents an S-Shaped graph.

Source: APS

The Mathematical model predicted that Netflix would perform poorly in the U.S. market but firmly in the international market. While in the past the model had been very accurate, it failed to contemplate the effect that a price increase would have in Netflix´s ability to add subscribers.

The results and guidance that Netflix showed were quite telling. First, Netflix Subscribers declined in the U.S. from Q1 to Q2, which could be a result of market saturation finally catching on, like the model predicts, or because of the increase in the subscription price.

Source: Author´s Charts with Netflix Info

International performance was much lower than expected, which reflects that Netflix´s pricing power is not strong and price increases do have a significant impact on the number of subscribers the company can get.

Source: Author´s Charts with Netflix Info

If we compare predicted revenue to actual revenue, Netflix delivered a better result than expected.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Usually, sacrificing market growth to obtain greater financial growth is not bad. It is a strategy that giants like Apple (AAPL) have done well. However, as Disney and AT&T will soon introduce their streaming service, the price increase could prove to be a bad long-term strategy.” data-reactid=”55″>Usually, sacrificing market growth to obtain greater financial growth is not bad. It is a strategy that giants like Apple (AAPL) have done well. However, as Disney and AT&T will soon introduce their streaming service, the price increase could prove to be a bad long-term strategy.

Source: Author´s Charts

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Netflix is rolling out price increases in Europe, which could drag international subscription growth even lower. Hopefully, the company learned its lesson with the U.S. Market but, if not, Q3 will continue to disappoint.” data-reactid=”64″>Netflix is rolling out price increases in Europe, which could drag international subscription growth even lower. Hopefully, the company learned its lesson with the U.S. Market but, if not, Q3 will continue to disappoint.

The chart above illustrates just how aggressive the price increases have been. Despite Netflix’s intention to roll out a price increase of more than 10% this year, it will likely be offering less content than what is currently available.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Disney´s strategy for its service will be to begin with a lower price tag to attract customers. People that have Amazon (AMZN) Prime Video might consider Disney´s less expensive option provides a better value.” data-reactid=”66″>Disney´s strategy for its service will be to begin with a lower price tag to attract customers. People that have Amazon (AMZN) Prime Video might consider Disney´s less expensive option provides a better value.

Compared to HBO, there will not be a big price difference. As AT&T pulls its content away from Netflix and into HBO, however, Netflix will have to prove that it can deliver the same quality service at a slightly lower price. Netflix will have a hard time offering sufficient popular content with Disney also pulling their content. While Netflix is investing heavily to create content, it will be competeting with the decades of content creation that Disney and AT&T have.

Valuation

Estimating that revenue growth is in the range of 3.4% and 21%, gross margin could range between 36.5% and 36.8%, R&D as a percentage of revenue is between 8.6% and 7.7%, and G&A as a percentage of revenue is between 17.2% and 15.9% we have the following chart.

Source: Author´s Charts

I like to use Peter Lynch’s ratio when valuing a stock. This method uses the ratio between the expected earnings growth plus dividends and the P/E of the stock to determine its fair value. A stock that has a 1:1 ratio is reasonably priced. The higher the number, the more underpriced the stock is.

Source: Author´s Charts

With this valuation, arguably, the stock is at worst overvalued by 77% and at best overvalued by 13%. As such, the stock is overvalued

Source: Author´s Charts

I would typically build a risk chart for the current and future prices of the stock to determine the level of risk and the statistical value of investing in the company. In this case, the chart would only reveal that the stock has low chances of going up in the following years.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Some might argue that Netflix is worth more than $139. For example, Wedbush analyst Michael Pachter rates NFLX a Sell with $188 price target. (To watch Pachter track record, click here)” data-reactid=”97″>Some might argue that Netflix is worth more than $139. For example, Wedbush analyst Michael Pachter rates NFLX a Sell with $188 price target. (To watch Pachter track record, click here)

However, if Netflix is going to struggle to grow for the foreseeable future, it is most likely a company on its way down.

Conclusion

The core business of Netflix is favorable, but the current price is gravely overvalued. Even if Disney´s incursión into streaming is not successful and Netflix goes to the top side of the estimates, it might not give a payback big enough to justify holding the stock.

Although the level of debt is mild, last year´s performance was high, and the financial solidity is favorable, the company has serious problems. The level of risk is tremendous, the potential upside is dreadful, the expected performance for next year is horrible, and the anticipated return for the foreseeable future is terrible.

Netflix’s short-term and current strategy is good, but when AT&T and Disney launch their services, the higher price tag will hurt Netflix’s growth prospects. Soon might even come the time to short the stock, especially if there are rallies mid-quarter.

Netflix took advantage of an inefficient business model that was not leveraging technological advances and disrupted it. Now, they have become complacent, and the disruptor will become the disrupted.