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Why the Netflix Stock Drama May Not Have a Happy Ending

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It's been less than five months since Netflix shares were trading near 52-week lows, below $55 each, and the company couldn't do anything right. Now, after reporting stunningly strong results for the fourth quarter – much better than the market had been expecting – its shares are changing hands for $169.56.

Admittedly, a big chunk of the stock's whopping 73 percent gain in the last three trading days likely has come from the fact that the legion of short-sellers who have been dogging Netflix (NASDAQ: NFLX) for more than a year sprinted to cover those bearish bets. But a cluster of upgrades on the part of analysts at Lazard, J.P. Morgan, Raymond James and elsewhere give a kind of Good Housekeeping-style seal of approval to the rally.

The suddenly rediscovered willingness to believe on the part of Netflix investors is just a little bit irrational – especially when set beside what's happened to Apple. In Apple's case, investors witnessed some minor disappointments and spotted indications that the company's growth rate would no longer be as astonishing as before; that a growing array of challenges to its dominance in smartphones and tablet computers likely would mean that the company would offer more modest growth. The stock has been hammered. In contrast, all Netflix had to do was post better than expected results, and suddenly it is the market darling of the month.

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The problem is that one quarter's results aren't enough to build a bull market case for Netflix. True, the company has added two million new subscribers to its video streaming business. But how "sticky" will those subscribers be over the coming months and years? The quick collapse of Netflix's original DVD mail rental business in the face of the new streaming technologies show just how rapidly consumer attitudes can change, and Amazon (NASDAQ: AMZN) could well prove to be a ferocious competitor in the streaming arena. Netflix's library of streaming content simply isn't as all-encompassing as its DVD rental library once was, meaning that it is more vulnerable to actual or potential competitors.

Moreover, if you dig beneath the outsize positive surprise, Netflix's results really weren't all that lovely to look at. The company may have posted a surprise, but profits were still nearly 80 percent below where they were in the year-earlier period. Meanwhile, the company's costs are climbing – and it is unlikely indeed that acquiring content is going to become cheaper any time soon. True, Netflix has struck deals with the likes of Disney (NYSE: DIS) – but will be paying a fair (translation: high) market price for that content. Activist investor Carl Icahn has accumulated a stake in Netflix, but a poison pill preventing him from acquiring a larger position may limit his ability to follow through on what he has said is a plan to maximize shareholder value, possibly through a sale of the business.

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Neither Netflix nor Apple are the companies they once were. When Netflix made its debut, it was that rare thing: a truly innovative business model made possible by the Internet. When Apple made its push beyond computers and into the world of personal electronic devices, starting with the iPod, it, too, was an innovator. Neither could be challenged. Today, both are grappling with mature products that have a relatively high market penetration rate. Neither is as unassailable as once was the case – that is the normal corporate life cycle kicking in.

For Netflix, the problem is that it isn't sitting atop a massive cash cushion that can help alleviate the problem, as Apple is, and that its margins on what it does do are less robust than those at Apple. It's hard to imagine how Netflix is worth some 160 times estimated 2013 earnings. That's the kind of valuation you apply to a company with a unique product that consumers view as a must-own, and for which they are willing to pay any price. That isn't Netflix.

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In a nutshell, Netflix is a high expectations stock for which the combination of a positive earnings surprise and a short-covering rally has ignited a somewhat bizarre market gain. But at least that has created a great selling opportunity for investors who snapped it up as a potential value stock midway through 2012.

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