The Netflix Growth-Monster Has Hulk-Smashed Its Rivals… But What’s Next?

by David Fessler, Advisory Panelist
Friday, December 10, 2010: Issue #1405

Here’s an easy one for you: Name any growth stock.

Which names spring to your mind? Google (Nasdaq: GOOG) is an obvious one. Or perhaps Apple (Nasdaq: AAPL).

But how about another company that has carved out its own niche, thanks to some creative, out-of-the-box thinking and has crushed its competition in the process? So far out of the box, in fact, that Wall Street analysts can’t even grasp what the box is.

I’m talking about Netflix (Nasdaq: NFLX) – a company that has taken a really long-term view of its market. Heck, the firm has redefined its market, much to the dismay of its rivals.

Bye-Bye, Blockbuster

What a difference a few years makes…

In February 2009, I wrote about a company that was thinking outside the entertainment box. It had just surpassed nine million subscribers and was solving the problem of expensive nights at the movies.

With the average movie ticket costing $7 to $10, plus drinks and snacks, that’s $20 per person – or $80 for a family of four – to go to the movies. As a result, Netflix became incredibly popular.

At the time, the stock was selling for around $36 a share. Today, it trades for $194 – an astonishing gain of 439% – as its subscriber base has ballooned to more than 16 million.

In the process, it’s crushed competitors like Blockbuster, Inc. (OTC: BLOKA. PK). Once a high-flyer in the video rental business, Blockbuster’s share price has collapsed from around $1.25 in February 2009 to just 16 cents today. Buying its shares today is akin to tossing your money out the car window the next time you’re on the freeway, as Netflix’s popularity has almost driven Blockbuster out of business.

But Netflix is just getting started…

A 111% Subscriber Surge in Less Than Two Years for Netflix

By the end of the year, Netflix expects to report a subscriber base of 19 million. That equates to just 17% of the 116 million U.S. television households, which gives it plenty of room to grow.

How did it achieve this? Simple: It decided to send the videos to you, rather than the other way around. I remember getting in the car to go to Blockbuster or Hollywood Video to rent movies. Then you had to drive back again to return them.

One can only guess at the amount of gasoline that Netflix is saving Americans by mailing videos out instead. Plus it gives those few remaining U.S. Postal Service employees something to do.

But not for long…

Netflix’s Instant Movies Turns Into Instant Profits

With the introduction of the company’s “Watch Instantly” option, waiting for your rental to arrive in the mail is becoming so yesterday. You just download the movie right to your home.

The service is growing in popularity (and is a big hit in the Fessler household). And while not every video is available to watch instantly, more are being added all the time. It’s truly is the sweet spot of the video rental market.

I expect Netflix to continue its transition away from physical discs toward streaming videos. Doing so will slash its handling and postage costs to zero, sending a greater percentage of its monthly fees toward its bottom-line profits instead.

Not only that, the company is expanding beyond the United States and recently introduced its movie-streaming service to Canada.

So what’s next for Netflix?

The Most Important Equation: Share Growth Follows Earnings Growth

If you want to make money in the stock market, first and foremost, look at earnings growth. Why?

Because as we’ve said here time and again, higher share prices follow higher earnings.

That’s certainly been true for Netflix. Its third quarter year-over-year net income grew 26%, while its earnings per share rocketed 35% higher.

Shares responded in kind and are up 79.6% since the beginning of the third quarter. But can that run continue?

I think it can…

Is Netflix Still a Compelling Investment? You Bet…

Consumers are still spending judiciously and going to the movies doesn’t often make the list of discretionary spending. That’s why Netflix has seen such a boost in its subscriber base.

Some forecasts estimate that Netflix will boast 55 million subscribers by 2015. That’s a hefty increase from the current 19 million… but given that the company nearly doubled its subscribers over the past year, it could be more realistic than most analysts think. That’s because great outside-the-box companies with dominant positions in their respective markets are capable of amazing growth. And it could well continue with Netflix.

Good investing,

David Fessler