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Stocks  | July 19, 2019

Everybody loves the hottest stock on Wall Street. Until they don’t.

Investor favorite Netflix crashed by 10% in moments Wednesday evening, after the online streaming company stunned the market with a loss of subscribers in the second quarter.

Short sellers had been ramping up their bets against the stock in recent months as it had boomed. The so-called short interest had risen by a third this year. Hedge funds and other smart bears booked about $700 million in a few moments as the stock tanked.

Whether they take their profits, or double down on their bets, will probably drive the stock’s next move.

Has the market overreacted? Maybe.

But before you rush out to buy Netflix on the dip, chew on this: Even after the plunge, Netflix is trading at around 70 times forecast per-share earnings, according to FactSet data. In other words, investors are paying $70 for each dollar of expected after-tax profits for the next 12 months. That’s a 1.4% return.

That’s not just expensive. Those are nosebleed valuations. The Wall Street average: 18 times forecast per share earnings.

You’d only pay 70 times a company’s earnings for a stock if you thought those earnings were going to grow really quickly in future years, doubling and redoubling in short order.

And sometimes that’s the smart gamble. Especially if you’re looking at a small, early-stage company that’s just about to hit hockey-stick growth.

But Netflix isn’t some tiny company growing from a minuscule base. It’s already in the top 50 companies by market value in America. The company is valued, even after the latest drop, at $158 billion.

That’s more than Kellogg’s, Nasdaq, Kroger, Wynn Resorts, U.S. Steel, M&T BankeBay, and the company that owns the Empire State Building ... put together.

Total net income of those companies last year: Over $11 billion, or 10 times as much as Netflix.

Right now everyone on Wall Street is in love with hot “growth” stocks like Netflix.

In the past five years, the MSCI World Growth index has risen 47%.

The rival value index? Just 9%.

One problem: Historically, it’s been a bad bet.

Over the long term, growth stocks overall have proven a much worse investment than boring “value” stocks. Turns out, in general you are much better off buying cheap stocks that are making big money today than buying expensive stocks that might make big money some time in the future.

It’s not even close. Since 1974 the MSCI World Value index, with dividends reinvested, has produced double the total returns of the growth index. Double.

Even finance professors Eugene Fama and Kenneth French, high priests of the “perfect market” cult, admit the market isn’t perfect when it comes to growth and value.

Before the latest slump, Netflix has buried more bears than you can count. Netflix is certainly a well-run company. CEO Reed Hastings engineered a stunning turnaround seven years ago after the company got into a much worse mess than this one. Bet against this stock at your peril.

But skeptics question the stock’s popularity.

Why should Netflix be compared to technology titans like Google-No-Wait-Alphabet, Amazon or Facebook? Does its industry look like theirs? Does it have the same winner-takes-it-all characteristics? Is Netflix, like them, a natural monopoly?

Netflix is either already competing, or will soon be competing, against every major media producer or alternative streaming operation in the world. It’s already losing “Friends,” “The Office,” and Disney programming to original rights owners.

(Hastings is now claiming this is a good thing, as it will free up more money to invest in original programming. Sure, why not? But if original programming offered a higher return on investment, why hadn’t he switched the budget over already?)

Netflix, along with the other big players in streaming, says the way to win the subscriber game is to produce the best original, exclusive content.

But it’s a brutal industry. As they say in Hollywood, you’re only as good as your last movie. AMC Networks made “Breaking Bad” and “The Walking Dead,” which is about as good as it gets. The company’s value today: $3 billion, or 2% as much as Netflix. It’s halved in five years.

Sure, it’s a different business model. But if programs like that aren’t good enough to win, what is?

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