Surprise Ending for Netflix?

03/16/2010 12:00 pm EST

Focus: STOCKS

Jocelynn Drake

Financial Analyst, Schaeffer's Investment Research

Jocellyn Drake of Schaeffer’s Investment Research says there’s too much pessimism about this high-flying video-rental stock, and it could fool a lot of investors.

This recent article on MarketWatch (“Netflix Investors Don’t Seem to Mind a Little Froth,” March 4th) takes a closer look at the growing competition that Netflix (Nasdaq: NFLX) faces. The stock reached the $70 mark [recently]—a fresh all-time high that was above many analysts' price targets and up a whopping 40% in just five weeks.

"Once the stock topped $70, many analysts faced the choice of either raising their price targets—and justifying a rather generous multiple to clients—or downgrading the stock,” the article said.

Analysts at Bank of America/Merrill Lynch, Susquehanna Financial Group and Kaufman Bros. chose to downgrade.

At its current levels, Netflix is trading at about 27 times projected earnings over the next four quarters. While that may be a bargain compared to Amazon.com (Nasdaq: AMZN), which trades at about 50x earnings, Netflix is at a 48% premium to the Standard & Poor’s 500 average of 18x.

Analysts remain doubtful. Marianne Wolk, an analyst with Susquehanna, wrote that her downgrade was primarily a valuation call, after its shares reached her price target. "At the current levels, we believe many of the positive attributes of the Netflix story are now better appreciated by investors," she said.

Furthermore Tony Wible, a Janney Montgomery Scott analyst who downgraded Netflix February 23rd, [has a Sell recommendation]. "It's really based on that fact that you are going to see intensified competition."

In the digital world, Netflix is facing rivals such as Apple's (Nasdaq: AAPL) iTunes store, Amazon's own online movie business, new pay TV channels, and Comcast 's (Nasdaq: CMCSA) impending acquisition of NBC Universal.

Overall, Wall Street is relatively pessimistic toward the shares, as 14 of the analysts following NFLX rate it Buy or better, while 17 analysts give it a Hold or worse, according to Zacks.

Furthermore, options players are giving the stock the cold shoulder. The Schaeffer's put/call open interest ratio for NFLX sits at 1.67, as put open interest outnumbers call open interest among options slated to expire in less than three months.

Furthermore, the ratio falls in the 91st percentile, indicating that traders have been more bearishly aligned toward the shares only 9% of the time during the past year.

The International Securities Exchange (ISE) has also seen an increase in put trading, as 4.5 puts have been purchased to open for every one call purchased to open during the past ten trading sessions. This ratio of puts to calls is higher than 98.7% of all those taken during the past year, pointing to a growing skepticism.

The stock has soared a whopping 22% since the beginning of the year and remains above support at its ascending ten- and 20-week moving averages. This wealth of pessimism indicates there is still sideline money available that could jump on the stock's bullish bandwagon and power it higher during the near term.

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