“Short and Stupid”, or “God I’m Short!”
Yes, that could be a description of me, physically and mentally! (not really, I’m on the tall side, but for the sake of poetic license…) I rarely ever take a short position. The only times I have, the outcome has more often than not been disappointing. In general, I think shorting is a loser’s game. To play it right you have to have a very different emotional mindset than the average long investor, and I really don’t think I have that mindset. But here goes anyway. I’ve shorted Netflix. I know. I know. Everyone will now think I’m either stupid or crazy, or both! Netflix is one of the biggest success story of the past decade both as a company and as a stock.
So why am I short? First let me say that my position is relatively small and I have set a limit on my potential losses. That said, I have a very simple thesis. Netflix earned $.15/share during the 4th quarter of 2016. It is trading at $140. That makes the annualized PE something like 230. What stock trades for a normalized PE of 230??? OK, so you think Netflix deserves that PE due to its blazing earnings growth? Not really. Check the figures, earnings are down over the past couple of years. They’re in subscriber acquisition mode. They’ve been reinvesting most of the incremental dollars from those incremental subscribers in what? marketing and programming! “Great!”, you say, “they are building a library that will increase their asset value”. You’re right, but the asset value is not growing as fast as they are burning cash. One of the problems is they are on a growth trajectory, driving subscriber growth by investing in original programming and marketing. It is unclear what will happen when they begin to reach subscriber saturation (acquisition costs increase for incremental subs) and they cut back on marketing. Will the subs stay? Will they stay if Netflix cuts back on new original programming? Will Netflix be able to bump up subscription costs enough to finance additional original programming AND incremental profits for owners? I do believe last year’s price increase saw some consumer resistance, and it really wasn’t that big an increase. Will new players come into the market (Amazon, Apple) and force Netflix to INCREASE their programming budget in the face of low, no or even diminishing subscriber growth? Will new technologies make Netflix’s streaming technology obsolete, just as Netflix is making linear cable program delivery obsolete? None of this is clear. However, it seems to me beyond common sense to pay 230x earnings (or even 50x earnings) for a company whose future is so uncertain. There you have it.
The sticky part of my thesis is that I could be 100% right and lose my shirt; its is not clear that the thousands of enthusiastic Netflix share owners will ever agree with me. They may be content to hold their shares when Netflix shares trade at 500x earnings i.e. at twice today’s stock price! There is no real catalyst to bring the share price down into the stratosphere, not to speak of to earth.
This is a calculated bet on my part. The market is priced relatively high right now. I think we could see a pullback sometime during the next year, and I think the Netflix share price will prove extremely vulnerable during any pullback. However, my strategy is full of giant holes. I’m ready to call it a day and eat my losses if Netflix shares continue their upward trajectory and hit $160/share. Yup, its like going to the casino floor and taking only $100 with you for ‘entertainment’. You leave your credit cards in the room and tell yourself that you won’t go back and get them. That’s why I’m writing this post… so I can’t ‘go back to my room and get my credit cards’. I’ll let you know how this works out…If I have mud on my face, so be it.