Why leave the comfort of your own home to rent a movie for $4.99 and worry about incurring late fees when you can instantly stream films online? For only $7.99 a month Netflix (Nasdaq:NFLX) offers unlimited 24-hour access to thousands of movies and TV shows, which can be simply ordered online.

IN PICTURES: 20 Tools For Building Up Your Portfolio

Impressive Growth
With nearly 17 million subscribers, Netflix has modernized the way people watch movies. Much like Amazon (Nasdaq:AMZN), which adopted a business model without brick-and-mortar facilities, Netflix is bringing similar changes to the movie industry. With rapid changes in consumer behavior patterns, Blockbuster and Movie Gallery both filed for bankruptcy earlier this year.

Undoubtedly, NFLX has been one of the hottest stocks on the market, producing returns of 220% over the past year. Since going public in 2002, Netflix has produced a total return of over 2000% as its revenues increased from $153 million to over $2 billion for 2010. Furthermore, despite reducing its price from $20 a month to $9.99 for DVD mail delivery services, management has managed to run the company more efficiently and improve operating margins every year since the IPO. As Netflix begins to rely more on streaming content rather than mail services, margins are likely to continue to improve.

Netflix was probably largely helped by the recession as basic earnings increased from $1.36 in 2008 to $2.05 in 2009 and the number of users increased from 9.4 million to 12.3 million. However, as the recession fades, Netflix continues to grow at a rapid pace.

With a strong balance sheet, stellar cash flow performance, a $300 million share repurchase plan, effective management (CEO Reed Hastings was Fortune's businessperson of the year) and ample growth opportunities, investing in Netflix has one main draw back: the current $185 stock price.

Bearish Stance
In a December 16 article that appeared on SeekingAlpha.com, Netflix bear Whitney Tilson makes a strong argument that the rapid shift to streaming movies marks the beginning of the end for the company. Basically, the industry has undergone massive changes from brick-and-mortar facilities, to mail subscriptions, to now, streamed content. As the online business grows in importance, Netflix will be competing with big-name competitors such as Apple (Nasdaq:AAPL), News Corp (Nasdaq:NWS), Google (Nasdaq:GOOG) and Amazon, among others. Due to the increase in competition and Netflix's high margins, which have spurred resentment from movie studios, profitability is not likely to reach the levels implied by the stock price.

Additionally, in order to compete with other big name players, Netflix will have to significantly expand its content base, an area in which it lags its competitors. Based on the analysis conducted by Whitney Tilson, Netflix had only 17 of the most popular 120 movies of interest; in comparison, Time Warner Cable's (NYSE:TWC) video on demand had 41 and iTunes carried 77 titles.

Adding more titles will not come cheap, especially if Netflix begins offering newer titles. Although the company has been able to expand its library for a relatively low price in the past, this trend is likely to reverse. In 2008, Netflix paid approximately $25 million to Starz for its content; according to the New York Times, media analyst Michael Nathanson called it "probably one of the dumbest deals ever. Starz gave up valuable content for tens of millions of dollars.'" When such contracts are renewed, Netflix is unlikely to get such a stellar deal, which will surely hurt the company's margins.

Bottom Line
While Netflix may one day become the movie equivalent to Apple's iTunes, competitors will not let this be an easy road. (These dreams are likely to burst - and may blow away your financial future in the process. See 4 Fatal Financial Fantasies.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  5. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  6. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  7. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  8. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  9. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  10. Stock Analysis

    GoPro's Stock: Can it Fall Much Further? (GPRO)

    As a company that primarily sells discretionary products, GoPro and its potential falls right in line with consumer trends. Is that good or bad?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center