Sunday, January 31, 2016

NETFLIX: Valuations, Competition, and Questionable Accounting Point To Potential Crash

Netflix (NFLX) may undergo one of the greatest collapses, and even bankruptcies, in stock market history.


It is not only the fierce and increasingly-powerful competition, subscriber growth hurdles, and enormous valuations that could cause Netflix's rapid downfall each on its own; but also, and even more devastating, it is the tremendous (and mostly hidden) debt, extremely weak financials, insider selling, and numerous accounting "red flags" that potentially make Netflix one of the best short opportunities ever.

To be fair, Netflix (NFLX) is an exceptional service and still a top source for video streaming and content. It "disrupted" the media industry and was a leader in this new form of video technology. Netflix should be commended for its revolutionary effects on media and technology as well as its award-winning original content, among other achievements. Partly or mostly due to Netflix, we can now get millions of videos on demand, anywhere we go. Furthermore, the "On Demand" trend in media consumption is relatively still in the early to mid stages, and media companies don't truly know where the future is heading. Many have discussed the trend away from traditional cable, known as "cord-cutting". Interestingly, we may be seeing a shift towards an "a la carte" or "pay per view" model where customers choose specific channels, events, or videos rather than paying for a large package with many channels they don't need.

It is definitely possible for Netflix to succeed. Netflix could very well continue to grow its subscriber base, flourish in its international expansion, and produce more massively-popular and award-winning original content.

Source: SEC, Netflix 10-K

However, just because Netflix is a great service or company doesn't mean it's a great stock.
In fact, Netflix (NFLX) is a terrible stock, and here's why:


1) EXTREME VALUATIONS

Netflix has already seen a significant drop its stock price (down over 30% from it's December 2015 high), yet its valuations remain highly inflated and not sustainable.

Source: Finviz (http://finviz.com/quote.ashx?t=nflx)

P/E --> With a market capitalization of $39 Billion as of January 31, 2016 (was over $50 Billion), Netflix has a sky-high Price-to-Earnings (P/E) Ratio of 328 and a Forward P/E Ratio of 85. A P/E ratio higher than 30 or 50 is generally too much even for fast-growing technology companies.

P/B and PEG --> Netflix's Price-to-Book (P/B) Ratio is 17.66, and its PEG Ratio is above 10, both extremely high considering these ratios should ideally be closer to 1 or 2. They are exponentially higher due to high investor expectations, but expectations are perhaps too high.

BV/Share --> With a stock price close to $100 per share, Netflix's actual Book Value is far below, at only $5.20 per share. The disparity is huge.

Cash/Share --> Netflix has only $5.40 per share in cash, a very small amount of liquidity and cash needed to run the company or weather a growth slowdown.


2) TINY PROFITS, NEGATIVE CASH FLOW

Though management claims aggressive international expansion and production of original content is to blame for its low Net Income and bottom line, such poor performance cannot continue for much longer without severely hurting the company.

As you can see below, though the number of streaming memberships has grown, this has not translated into higher Net Income.
Source: SEC, Netflix 10-K

Net Income (NI) --> With a $40 Billion market cap and nearly $7 Billion in Revenue, Netflix only generated $122.6 Million in Net Income. It is barely profitable.

Source: Statista (http://www.statista.com/statistics/272561/netflix-net-income/)

Operating Cash Flow (CFO)--> A well-known "red flag" in accounting and financial analysis, a negative Operating Cash Flow (CFO) is a sign of potential trouble ahead. Netflix's Cash Flow from Operations is -$750 Million (yes, that's NEGATIVE 750 million).

Free Cash Flow (FCF) --> Similarly, Netflix's Free Cash Flow is negative. Another major red flag.

Source: GuruFocus (http://www.gurufocus.com/term/total_freecashflow/NFLX/Free%252BCash%252BFlow/Netflix%2BInc)


3) DEBT BURDEN

One of the most disturbing aspects of Netflix's financials is its large and very murky debt accounting.

The company publicly takes pride in its relatively low debt levels (~$2.5 Billion), but mostly fails to acknowledge the massive $10 Billion+ in additional debt that remains in its "Off-Balance-Sheet Liabilities". This means that Netflix actually has a total debt and financial obligations of more than $15 Billion!
Source: SEC, Netflix 10-K, Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management has slyly and cleverly kept the massive debtload off the books in order to make the financial strength and health of Netflix look much better, yet is completely detached from reality. Though management has found clever technical ways to define these liabilities and keep them off the Balance Sheet, such behavior is at the very least questionable if not outright fraudulent.

If Netflix keeps billions of dollars of obligations off the balance sheet, it should likewise also keep its streaming content assets off the balance sheet. But it hasn't; Netflix has managed to hide more than $10 Billion of debt while adding billions of dollars in assets:

Netflix cannot afford new content without taking on more debt. Its debt is growing faster than its profits, and this can't last for long.


4) GROWING COMPETITION

Netflix was the first big winner in the video streaming subscription service, and competition has not yet caught up, but the number of competitors as well as their growth momentum is increasing.

Netflix is a small player in comparison to the other major players in this space - giants like Amazon (AMZN), Google / Alphabet (GOOG)(GOOGL), Disney (DIS), CBS Corp (CBS), Apple (AAPL), and Time Warner (TWX), with Hulu gaining steam and with Facebook (FB) increasingly interested in video content.
Not only does the competition take away some of Netflix's subscriber base, but it creates large bidding wars and increased prices for the video content, which Netflix can barely afford in the first place. On the other hand, giant companies like Amazon (AMZN), with sufficient resources at their disposal can better afford the content and may be able to price Netflix out.



Netflix is left with a big and perhaps insurmountable hurdle: Either it pays exorbitant sums for content and puts itself further into financial distress, or it stays on the sidelines while its content library dwindles or becomes stagnant, leading to loss of subscribers or much slower growth. Lose-lose situation.


5) MASSIVE INSIDER SELLING & QUESTIONABLE EMPLOYEE OPTIONS COMPENSATION

While Netflix has hovered at or near all-time highs, insiders and very important directors and officers have sold millions upon millions of dollars in stock (See: http://finance.yahoo.com/q/it?s=NFLX+Insider+Transactions ). Sometimes this is just profit taking, but sometimes it is a sign of a lack of faith in a continued rise in the stock price. If those on the inside, who have a better view of the company's operations and growth opportunities, don't have faith in the stock, why should other investors?

Source: Forbes

Moreover, the insider selling is further muddled by a confusing employee compensation arrangement. Employees and directors are given options as compensation, but somehow those options are being quickly exercised at a cost of nearly a tenth of the share price on the open market and sold for millions of dollars. It's as if the company is creating shares out of thin air and giving them to employees to sell on the open market for ten times the profit.

Management has attempted to appear fair and sacrificing for the good of the company by accepting reduced salaries. But if this options compensation is as shady as it seems, there could be major trouble ahead.


6) WEAK TECHNICALS

After soaring by more than 1000% from its 2012 lows and also being the best-performing S&P 500 stock of 2015, Netflix's (NFLX) parabolic rise is dangerously close to collapsing on itself.

On the long-term monthly chart below, you can see the giant increase in the stock price as well as the significant drop since reaching the all-time high in late 2015. Though it is still uncertain, this looks like it could be a long-term peak or all-time high never to be reached again.
NFLX Netflix, Inc. monthly Stock Chart
Source: Finviz

On the weekly chart, a similar ominous signal is emerging - what appears to be a topping pattern. In the chart below, you can see a significant support level of $85-90. If NFLX falls below that level, there is plenty of space below. Moreover, though this pattern could bottom out here and continue the uptrend, it is very possible that Netflix (NFLX) is currently undergoing one of two major topping patterns - either a "Double Top" or a "Head and Shoulders". Additionally, the recent top in the stock at around $130 was accompanied by a major "divergence" in momentum. While the stock price was making new highs, the momentum (signaled by the Relative Strength Indicator (RSI) and MACD) was not matching those highs. Such a negative divergence is many times visible near major peaks, right before a big plunge.

Source: StockCharts.com


CONCLUSION

At the very best, Netflix (NFLX) is highly overvalued with huge expectations to live up to and the best stock performance already behind it.
At worst, it is a company rapidly losing to competition, financially unsustainable, overloaded with debt and a toxic balance sheet, and is potentially manipulating its numbers.
Though I am not calling Netflix a fraud, I am definitely seeing many "red flags" and questionable accounting. At the very least, investors deserve sufficient answers to these major concerns which could quickly drag Netflix into a death-spiral

Simply put, an investment in Netflix (NFLX) is not worth the risk, and the stock is instead a great short candidate. The next few fiscal quarters are critical in the growth or demise of Netflix.

Wednesday, January 27, 2016

Move Over Adele, Here Comes Rachael Price and Lake Street Dive

If you like Adele and powerful female vocals, check out Lake Street Dive!

Lake Street Dive performs on The Late Show with Stephen Colbert

Adele is a worldwide superstar known for her very powerful vocals, melodies, and heartfelt lyrics, and she deserves the credit and fan support.



She has released three albums so far in her career; all reached #1 on the UK charts, and reached #4, #1, and #1 in the US. She has had four #1 singles in the US already, including "Rolling in the Deep", "Someone Like You", "Set Fire To The Rain", and most recently "Hello".
Which one is her best song though? I personally assume one of her early #1 hits was most deserving, because she didn't have the already-existing huge fan base. Even though "Hello" is a great song, it's almost as if Adele's first single from this new album was destined to be #1. Millions of fans waited a few years for Adele's followup album, with high anticipation.

ALBUMS:
TitleDetailsPeak chart positionsSalesCertifications
UK
[10]
AUS
[11]
CAN
[12]
FRA
[13]
GER
[14]
IRE
[15]
NL
[16]
NZ
[17]
SWI
[18]
US
[19]
19 1341515213154
21
  • Released: 19 January 2011
  • Label: XL, Columbia (USA)
  • Formats: Digital download, CD, LP
1111111111
  • BPI: 16× Platinum[3]
  • ARIA: 15× Platinum[34]
  • BVMI: 8× Platinum[24]
  • IFPI SWI: 2× Platinum[35]
  • MC: Diamond[25]
  • NVPI: 9× Platinum[36]
  • RIAA: 11× Platinum[27]
  • RMNZ: 13× Platinum[37]
25
  • Released: 20 November 2015
  • Label: XL, Columbia (USA)
  • Formats: Digital download, CD, LP
1111111111
  • BPI: 8× Platinum[3]
  • ARIA: 8× Platinum[45]
  • BVMI: 5× Platinum[24]
  • MC: Diamond[25]
  • RIAA: 8× Platinum[27]
  • RMNZ: 7× Platinum[46]
Source: Wikipedia (https://en.wikipedia.org/wiki/Adele_discography)


SINGLES: 
TitleYearPeak chart positionsCertificationsAlbum
UK
[10]
AUS
[11]
CAN
[60]
FRA
[13]
GER
[14]
IRE
[15]
NL
[16]
NZ
[17]
SWI
[18]
US
[61]
"Hometown Glory"200719517886 19
"Chasing Pavements"2008228467321
"Cold Shoulder"1868
"Make You Feel My Love"451
"Rolling in the Deep"20102313121311
  • BPI: Platinum[3]
  • ARIA: 7× Platinum[62]
  • BVMI: Platinum[24]
  • IFPI SWI: 3× Platinum[35]
  • MC: 9× Platinum[25]
  • RIAA: 8× Platinum[27]
  • RMNZ: 2× Platinum[63]
21
"Someone like You"20111121412111
  • BPI: 2× Platinum[3]
  • ARIA: 7× Platinum[62]
  • BVMI: Platinum[24]
  • MC: 7× Platinum[25]
  • RIAA: 5× Platinum[27]
  • RMNZ: 3× Platinum[63]
"Set Fire to the Rain"111129661841
  • BPI: Platinum[3]
  • ARIA: 3× Platinum[62]
  • BVMI: Platinum[24]
  • IFPI SWI: Platinum[35]
  • MC: 5× Platinum[25]
  • RIAA: 4× Platinum[27]
  • RMNZ: Platinum[63]
"Rumour Has It"85601617268715216
  • ARIA: Gold[62]
  • MC: 2× Platinum[25]
  • RIAA: 2× Platinum[27]
"Turning Tables"623460854563
"Skyfall"20122531111218 Non-album single
"Hello"20151111111111
  • BPI: 2× Platinum[3]
  • ARIA: 4× Platinum[65]
  • BVMI: Platinum[24]
  • MC: 5× Platinum[25]
  • RIAA: 4× Platinum[27]
  • RMNZ: 3× Platinum[66]
25
Source: Wikipedia (https://en.wikipedia.org/wiki/Adele_discography) 


It's obviously extremely difficult, if not impossible, to match Adele's wondrous success. But don't you think Lake Street Dive should at least reach the Billboard Top 100?
I can definitely imagine some #1 hits, though that would just be an amazing prediction and a great ear for music. It's still too early to tell, but their new album comes out February 19, 2016.







Monday, January 25, 2016

Why Weather Forecasts Severely Underestimated The Blizzard of 2016

The Blizzard of 2016 is one of the worst/biggest on record for the Northeastern US (and especially NY), but almost all forecasts leading up to the storm were very inaccurate. Nobody was able to predict that record-level snowfall was about to blanket the region. Weather forecasts called for only 8 to 12 inches of snow in most cases. In reality, we got hit with over 26 inches of snow - the 2nd most in New York City history (missing the all-time record by only .1 inches!).

I knew this was going to be much worse than the 8 to 12 inches of snow expected, and here's how:

Human beings have a major tendency towards psychological bias, and this season we were all getting way too comfortable with a warm, mild, and snow-less winter.

Every day, our brains lead us to overestimate and underestimate all sorts of events, outcomes, and things. These miscalculations and false expectations are not necessarily our fault, since they are the result of very powerful cognitive biases and errors ingrained in human thinking. These natural biases are many times evolutionary advantages that help us quickly deal with or cope with daily situations, but they also cause many problems and lead us astray.

In this case, regarding the blizzard, most weather forecasts were subject to "recency bias". Recency bias, as its name implies, leads to an over-reliance on recent events, causing people to expect future outcomes to be similar to those of the recent past. 
For example, after a terrible recession, such as the Great Recession of 2007-2009, most investors and people in general were overly concerned with and overly expectant of another recession. Even if another recession was not imminent, most investors became so fearful of what happened in recent past that their recent memory had a disproportionately large effect on their thinking. Case in point, with so much fear of another recession since 2009, there actually has not been an official recession in the US for over 6 years! Recency bias in this case may have led millions of people to miss out on one of the greatest Bull Markets in history. Prudent investor behavior is important, but in this case it was taken too far. 
There are many varying examples of recency bias, which is also related to "Availability Bias" and "Representativeness Bias". The common thread between these biases is that an individual overestimates the likelihood or probability of something occurring (or not occurring) based on recent past or how easily something comes to mind. For example, people tend to be much more afraid of a shark attack than a car accident because a shark attack elicits vivid images and great fear; however, in reality, a car accident is much more likely. 

Back to the blizzard -- 

With such a warm and mild winter leading up to January 2016, most people had become too accustomed to the irregular weather. Instead of expecting the normal winter weather to eventually arrive, most people assumed it would continue. 
Even the weather forecasters, supposed "experts", were completely off the mark. With one of the biggest blizzards of all-time barreling its way toward the east coast, the forecasts called for only 8 to 12 inches of snow. 
Based on the snowless winter leading up to the blizzard, the forecasters were strongly biased by their recent observations - that a severe snowstorm was extremely unlikely. How could they expect a record-setting snowfall when we haven't even seen 3 inches of snow all winter? However, because of their bias, their forecasts severely underestimated the upcoming storm. 

This is how I knew we were about to get much more than 8 to 12 inches:

I was very aware that the winter was much warmer than usual and that the nonexistent snowfall was completely out of the ordinary. Unless this was going to go down as one of the warmest and most irregular winters of all time, I knew we would have to experience a major storm at least once. In my mind, winter was just about to get started.
So when I heard of the upcoming snow, I recognized the potential for most weather forecasters to be biased by the recent mild weather. I knew that many forecasters would have a problem with accepting that such a monster storm was approaching. Even if their forecasts pointed to 20 inches of snow, I expected many forecasters to minimize or reduce their numbers. A weather forecaster wasn't likely to predict 20 inches of snow because he or she would look foolish if it turned out to be incorrect; with such a mild winter, why would the forecaster go out on a limb and predict a major storm? It would have been the correct thing to do, but unlikely to be done. 
Once I heard that forecasts were calling for a significant 8 to 12 inches, I knew that at the very least we were getting a disruptive storm. Furthermore, I knew that if forecasters were willing to predict nearly a foot of snow, the possibility of a major blizzard was high. 

Hours before it had even started to snow, I told my wife and brother-in-law (who was staying by us with his girlfriend for the weekend) that we were probably about to be stuck indoors for the entire weekend. Since most people can't even fathom a blizzard right now, I said, the forecasts are severely underestimating the amount of snow we are about to see. 
And then a record-setting blizzard showed up.


Based on this recency bias, we can expect that forecasters might OVERestimate the next snowstorm, because they will be thinking too much about this blizzard.