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

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  3. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  4. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  5. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  6. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  7. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  8. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
  9. Mutual Funds & ETFs

    3 Vanguard Equity Fund Underperformers

    Discover three funds from Vanguard Group that consistently underperform their indexes. Learn how consistent most Vanguard low-fee funds are at matching their indexes.
  10. Investing News

    Alphabet Earnings Beat Expectations (GOOGL, AAPL)

    Alphabet's earnings crush analysts' expectations; now bigger than Apple?
  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 >>
Trading Center