The article was written by Ayush Singh – Senior Analyst at I Know First. 

Netflix Stock Forecast: Summary

• Despite 28% YTD fall, shares of Netflix are overvalued.
• Increasing content cost will have a negative impact on subscriber growth and profitability.
• Long-term success hinges on international expansion.
• Patient investors should wait for a better entry-point.

Momentum stocks are off to a rough start to 2016 as many of them have lost considerable value and Netflix (NFLX) is no exception to it. The past few years have been great for Netflix, and the stock was even one of the best performers of 2015. Despite the strong momentum, Netflix couldn’t continue its upward trajectory in 2016 and is down almost 28% year to date.

Although a 28% dip looks compelling, I think investors shouldn’t hurry into buying the stock just yet. I believe Netflix has more downside potential and patient investors will get a better entry point in the short run. As a result, I think investors should wait for a further 10% decline in Netflix’s shares before initiating a long position.

Still Overvalued

I have been bullish on Netflix for over a year now, however I recently warned investors against buying the stock. I was expecting 2016 to be a rough year for the market, especially for momentum stocks, which is why I recently advised investors to short Netflix.

The primary reason for my short thesis was Netflix’s overvaluation. When I called Netflix a short, the stock was trading at over 340x trailing earnings. Despite the 25%+ dip since my recommendation, Netflix is still expensive and has a trailing P/E ratio of 295.

Clearly, despite the fall, shares of Netflix are overvalued, and investors have priced in years of growth. Subscriber growth in the U.S. has been one of the major driving factors behind Netflix’s meteoric rise. However, I believe the subscriber growth will eventually slow down in the coming quarters. Increasing subscription rates along with rising competition will take a toll on Netflix’s U.S. subscriber growth, which in turn will put negative pressure on Netflix’s shares.

Granted Netflix has tons of room internationally to expand its business, but I strongly believe its share price will resonate with the subscriber growth in the U.S. for the short-term. Netflix hasn’t bottomed yet and as a result, I think investors should wait for a better entry point.

Content Cost

Content cost is another massive headwind for Netflix going forward. With competition increasing, Netflix will have to greatly enhance its content so as to maintain strong user growth. However, buying content isn’t cheap. To put into perspective, Netflix spent $2 million per episode on The Blacklist and $1.35 million per episode on The Walking Dead.

With the rise in competition, it is only a moment of time before Netflix enters a bidding war with its peers. Consequently, the content cost will only increase in the future, which is bad for Netflix’s margins. It will probably be the subscribers who will have to bear the increasing content cost. However, increasing subscription price can slow down Netflix’s customer growth, which is another negative for investors.

Acquisition is unlikely

There was a recent rumor about Apple (AAPL) acquiring Netflix. Netflix’s shares jumped higher following the rumors, however I think investors shouldn’t bet on an acquisition at current levels. Despite Netflix’s overvaluation, a company like Apple will still have to pay a premium to buy it out,          and the chances of that happening are next to zero at least for now.

Although Apple has over $210 billion of cash, it will not acquire Netflix due to the latter’s weak profitability. Netflix has a wildly negative cash flow and very little profitability, which is why I don’t see Apple bidding for the stock in the near future.

Moreover, with the content cost increasing, Netflix’s profitability will likely decline further. Given the headwinds, I don’t think that a turnaround is a likely outcome for Netflix.

International expansion can drive long-term success

In 2015, Netflix announced that it will expand from 50 countries into 200. Less than a year after announcing its plans, Netflix has successfully completed the expansion process as it launched in roughly 130 countries last month. Netflix was supposed take about 2-3 years to implement its expansion plans, however the before-time completion shows that the company’s management realizes the potential of the international market.

International expansion is great news for Netflix investors, as in the long-run, it can add significantly to Netflix’s earnings and revenue. That said, there are a few roadblocks to its international expansion imitative.

Only a handful of third-party productions are willing to license their content globally due to several reasons like existing licensing deals abroad, and so many markets launched with thin content catalogs. On the bright side, Netflix’s CEO Reed Hastings claims that catalogs will expand. Finding the perfect balance between the adding domestic content in any particular as well as growing their original content is the key to Netflix’s success.

Netflix’s management said that it will be managing content for each region individually. As a result, I think Netflix’s international expansion will be successful. However, the expansion can cause some short-term pain for the company.

Netflix already spends billions of dollars on content and as mentioned above, the content cost will keep on rising. However, international expansion will further add to its expenses as Netflix will have to spend aggressively on marketing. The company earlier stated that it would spend about $1 billion on international marketing. However, since the company has speeded up the process of expansion, the marketing costs will shoot higher. Netflix is already offering free trails across the 130 countries and will need to spend a fortune on promotion as well. Hence, I wouldn’t be surprised if Netflix’s $1 billion budget is exceeded.

International expansion will be a positive in the long-term, however due to the growing expenses, I think Netflix’s shares will fall in the short–term. Hence, I think patient long-term investors should wait for a better entry-point.

Conclusion

For the short-term, Netflix’s share price will be driven by the subscriber growth in the U.S. Since I expect the growth to slow down in the near future, I think investors should avoid Netflix at current levels, and wait for a better entry point.

In the long-term, Netflix’s shares can move higher as it expands internationally. The company has plenty of room to expand and is entering new markets. International success can boost Netflix’s shares in the long run.

My long-term bullish outlook is echoed by algorithmic forecasts of I Know First.

I Know First uses an advanced state of the art algorithm based on artificial intelligence and machine learning to foresee market performance for more than 3,000 markets including stock forecasts, world indices, commodities, interest rates, ETFs, and currencies.

I Know First is the number one market opportunity finder and most importantly, the service provides their subscribers to feel confident in their ability to invest in the markets. Their algorithm or rather an assembly of many self-learning algorithms uses 15 years’ worth of data as an input. It is based on artificial intelligence, combining machine learning, elements of artificial neural networks and genetic algorithms. It is adaptable, scalable, and features a Decision Support System (DSS).

Their primary purpose as an organization is to deliver high-quality financial advice through accurate algorithmic stock forecasts. They constantly try to create a culture of growth, profitability, continuous improvement and enthusiasm throughout the firm, all of which for the benefit of their clients. On a daily basis, they aim to help subscribers to utilize the power of algorithms to make the best investment decisions.

The algorithm generates a forecast with a signal and a predictability indicator. The signal is the number at the center of the box. The predictability is the figure at the bottom of the box. At the top, a particular asset is identified. This format is standardized across all forecasts. The middle number indicates strength and direction, not a price target or percentage gain/loss. The bottom figure, the predictability, signifies a confidence level.

Previously, I Know First accurately predicted NFLX’s Stock bullish movement from January 9th, 2015. We can observe that in one year NFLX managed, with a signal of 329.73 and predictability of 0.5, to bring returns of 133.13% in this time horizon.

Having verified the accuracy of I Know First’algorithms concerning NFLX movement, let’s examine future predictions:

As you can see from the chart above, bright green 9.63 shows that the algorithm is bullish on Netflix over a one year period. However, the light green 1.37 and 3.62 in the forecasts above indicates weak bullish movement for Netflix in the next 3 months. Given Netflix’s high valuation, I don’t think buying the stock which has limited upside in the short-term is a good idea. The short-term risk/reward ratio is not favorable. I think if investors are patient, they can get a better-entry point into Netflix over the next few months.

To get your daily forecast for NFLX sign up here