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

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  3. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  4. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  7. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  8. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  9. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  10. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. 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 >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!