Netflix Stock Forecast

Netflix Investors Should Consider Profit Taking At These Prices

Summary

• Netflix’s stock price has had a meteoric rise during the current year, and increased another 10% after yesterday’s earnings report.
• Investors should consider profit taking at this level, as the international expansion numbers are less likely to shock investors going forward.
• The growing content costs and decreasing free cash flow can’t be ignored for much longer, and a period of consolidation is coming as the stock is now overbought.
• I Know First still likes the overall long-term outlook for Netflix, but believes the stock price cannot climb higher and will go through a period of consolidation.

Netflix, Inc. (NASDAQ:NFLX) once again had an outstanding earnings report in terms on subscriber growth, as the company beat expectations both domestically and internationally. With 3.28 million new subscribers during the company’s second quarter, usually its weakest, the stock price climbed over 10% in pre-market trading, continuing its rapid rise this year as the best performing stock in the S&P 500.

I Know First has written about Netflix a number of times since the beginning of the year with a strong bullish outlook, such as this article from January 9^th predicting that the stock would break out to new all-time highs after the earnings report due to subscriber growth from international expansion. Other articles from April and May argued that the stock price was still a good value and would continue to climb.

Figure 1. Source: YCharts

The stock price has now climbed over 132% since the first article and investors should consider taking some profits now. While the long-term outlook for the company is still strong, the stock appears as if it will enter a period of consolidation for the next few months.

The move into Japan could take longer to bear fruit than other international moves and the large estimates about the potential in China could be revised downwards moving forward.. Further, the original content costs are expected to increase even more.

International Expansion

Netflix CEO Reed Hastings has made the company’s expansion goals clear in the past, with the company hoping to be in all major markets by the end of 2016. Of the 3.3 million additional subscribers that signed up for the service last quarter, 2.37 million of them came from international markets, which is growing at a much faster pace than domestic.

Most of the remaining international expansion won’t take place until next year, as Netflix will only expand into Japan during the current quarter before entering Italy, Spain, and Portugal during the following quarter. Subscriber growth from international expansion is expected to remain strong, with guidance for an additional 2.4 million subscribers during the coming month.

Figure 2. Source: Statista

But the surprised reaction from these numbers could be coming to an end, and investors might be less impressed in coming months as international expansion costs continue to mount during the second half of the year. Investors now expect massive additional subscribers to come from international markets, and Japan is unlikely to quickly amount to additional subscribers, as Hastings acknowledged during the earnings call.

Hastings said, “…Japan is a unique market because it’s very brand sensitive. So Japan will probably be our slowest market to get to certain penetration threshold, but it may be one of our best markets in the long-term…” Growth from other international markets, such as Brazil and Australia where Netflix is already very strong, should uphold current growth, but investors won’t be taken by surprise by these numbers like they have in the past.

Further, Hastings and the rest of Netflix’s management team acknowledged that they are still unsure of when an entry into China could be expected. The team consistently harped that the country would be treated as its own region with a specific set of variables, and that it “hoped” to enter the market in 2016. This was far from a promising outlook, with no details of any partnership or how negotiations are going so far.

The announcement last month that Alibaba was partnering with Beijing’s municipally owned cable TV monopoly put a damper of Netflix’s potential China plans, which some analysts have viewed as justifying the current valuation. While Hastings and the rest of the management team could still find some way to enter the market, it for sure won’t offer as much as some were expecting, and some valuations could be reduced as a solution continues to evade the Netflix team.

Content Costs Still Growing

During the conference call, the original content was pointed to as a reason why the subscriber growth beat expectations, as programs like Daredevil and Orange is the New Black were released during the previous quarter. Currently, 10% of Netflix’s content is original, but Netflix hopes to increase that percentage during the next year.

To do so, the company’s content costs will approach $5 billion this year and are expected to grow by another billion the following year. While the exclusive, original content is key to the company’s future strategy and has been successful in driving subscriber growth, these escalating costs are sure to start worrying investors as the company’s free cash flow continues to fall. Free cash flow during the previous quarter fell $229 million, much more than the decrease of $59 million that analysts were expecting.

While investors are willing to overlook these poor numbers for the time because of the large subscriber growth, the skyrocketing stock has blown past reality at this point. The company’s stated goal is remaining breakeven globally until international expansion is completed and then receiving material profits for its shareholders. This sounds nice in theory, but if content costs continue to expand at this rate, profits could be hard to come by.

Figure 3. Source: YCharts

Competition in the streaming field is growing rapidly, and Netflix will need to continue funding more and more original content to keep its position as the market leader. Such a large valuation with an absurd P/E ratio is explainable with profits being put off into the future, but those profits might not be as great as once expected and it might take until 2020 until the full profits are realized. That leaves lots of time for something to go wrong, as has happened for Netflix’s stock in the past.

Netflix Stock Forecast Based on Algorithms

I Know First supplies financial services, mainly through stock forecasts via their predictive algorithm. The algorithm incorporates a 15-year database, and utilizes it to predict the flow of money across 2000 markets. The self-learning algorithm uses artificial intelligence, predictive models based on artificial neural networks, and genetic algorithms to predict money movements within various markets.

The algorithm produces a forecast with a signal and a predictability indicator. The signal is the number in the middle of the box. The predictability is the number at the bottom of the box. At the top, a specific asset is identified. This format is consistent across all predictions. The middle number is indicative of strength and direction, not a price target. The bottom number, the predictability, signifies a confidence level.

I Know First has had success predicting the movement of Netflix’s stock price in the past. In this one-year forecast from July 13th, Netflix had a strong bullish signal strength of 91.26 and a predictability indicator of 0.19. In accordance with the algorithm’s prediction, the stock price increased 60.84% during that time.

I Know First published a bullish article on Netflix, a video streaming service in the US and internationally, on Seeking Alpha. Having explained how I Know First’s algorithm works and providing an example of its success in the past, it is worthwhile to see if the algorithm agrees with the bullish fundamental analysis of the company. The three-month and one-year forecasts for Netflix are included.

Netflix has a weak, bearish signal for the 1-month and 3-month time horizons, most likely predicting a pull-back in the stock as investors could look to take some profits from the rapid stock price gains over the past year. While the long-term outlook for the company remains positive, the stock price has gone far beyond its past all-time high and is now overbought. The valuation has reached a level that the company cannot support and investors should look to take some profits from there investment.

Positive signal strength does not mean investors should automatically buy the stock. Dr. Roitman, who created the algorithm, created rules for entry for a stock such as Netflix. Using this trading strategy, an investor should buy a stock if the last 5 signal strength’s average is positive and if the last closing price is above the 5-day moving average price. When both of these conditions are met, it is a good time to initiate a position in the stock.

Conclusion

Netflix’s outlook for the long-term did not change that much during the most recent earnings report, but investors should not expect the massive gains during the last year to continue during the coming quarter. The deal with China looks murkier than ever, with the management team giving little as to how they plan to enter the market with their vague answers. With free cash flow continuing to fall further and original content costs continuing to rise, taking profits at current prices is a wise choice, as a period of consolidation is likely during the next few months. I Know First has a slightly bearish overall outlook for Netflix over the next three-months, supporting the fundamental analysis that the stock will go through a period of consolidation after the massive gains it made since the beginning of the year.