June 13th, 2007

Life Cycle Investing: Netlix (NFLX)

We’ve looked over the life histories of two bell-weather growth stocks, AAPL and GOOG, to see their progress from IPO (development) into growth (see my May 31 post titled Life Cycle Investing: Introduction). But what about stocks in the mature or declining phases of their life cycles? What can we learn from their behaviour. Four we’ll look at more closely are Netflix (NFLX), Lennar Corp (LEN), Starbucks (SBUX) and Whole Foods Market (WFMI).

The Netflix (NFLX) IPO on May 24, 2004 at $8.10 was ill-timed since the market hadn’t yet hit bottom and wouldn’t turn until the following March, 2003. However, if you had purchased the stock then and held through it’s post-IPO 50% decline to under $3.00, you would have still made approximately 480% over 18 months in January 2004 at near $40. Actually, NFLX crossed back over the resistance trendline at its IPO price simultaneously with the markets hitting bottom in March, 2003. (Perhaps there’s a lesson to be learned here about never buying ….. or launching, for that matter …. IPO’s during a bear stock market, regardless of the stock’s “story”!)

But the true story is in April and July, 2004 when NFLX failed to continue moving into new high territory. Actually, it failed its attempt to form a consolidation pennant and broke down with a gap on mid-July 2004. The drop continued until hit the IPO price resistance/support trendline in March 2005, a collapse of 75%. At the same time, the market, as measured by the S&P 500, successfully broke through the neckline of a reverse head-and-shoulder bottom signaling a significant improvement in the market’s health.

This negative relative performance should have provided sufficient warning that Netflix had moved out of the growth phase of its life cycle, past the maturity phase and was now in the decline phase. The fundamentals substantiated that. DVD rentals were giving way to movie downloads, cable movies-on-demand and alternative distribution channels. The company would literally have to reinvent itself if current and future investors had any hope for seeing future share price appreciation, let alone being able to sleep at night.

It would only be fair to say that after retreating back to it’s IPO price, NFLX did increase by 236% again to April, 2007 but as mentioned earlier, though respectable, that peak was lower than the earlier inflection point. And, as the market broke to new all-time highs, NFLX has floundered.

To be fair, one could draw the lower boundary support line of a long-term, highly volatile pennant pattern. Given the stock’s performance, it’s likely that the breakout would be on the downside. However, if the stock did break out on the upside then it would be because of significant, currently unforeseen, changes indicating the reinvention/rebirth of the company and the birth of a completely new life cycle. Short of that, Netflix (NFLX), as the business is configured today, is a stock that is at the end of its life cycle and, at best, is a short candidate.

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  • genny

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