Switch off the TV and short Netflix

Netflix's rivals are investing heavily in content, making the streaming pioneer’s life harder. Traders should go short.

Last October, I suggested that you short the online streaming service Netflix (Nasdaq: NFLX). This proved to be a mistake: six months later I recommended that you cover your position at a loss. Indeed, if you'd bought Netflix in late December when it was $234, and sold when it was around $380 earlier this month, you would have made a return of over 60%. However, after a disastrous quarterly earnings report Netflix's shares have fallen to $310, their lowest level since January. So is this a buying opportunity, or is now the right time to bet against the streaming service?

The reason why the latest quarterly-earnings figures have hit Netflix's share price so hard was not disappointing revenue or earnings. In fact, both figures were largely in line with expectations. The real shock was that Netflix added only 2.8 million new subscribers, as opposed to the 4.8 million people analysts were expecting. What's more, the number of American subscribers actually fell by 126,000, compared with an expected increase of 352,000. This is important because Netflix needs to keep growing at a rapid rate to justify a valuation of 55 times 2020 earnings and 4.5 times sales.

Is this just a temporary dip?

Netflix bulls argue that this is just a temporary dip driven by the fact that the group has decided to raise its monthly prices from $10.99 to $12.99 for the so-called standard plan, and $13.99 to $15.99 for the premium one (the difference is based on the picture quality and the amount of content you can download). It also raised standard monthly prices in the UK from £7.99 to £8.99.

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However, the reason it is raising its prices is that the cost of delivering a huge amount of content has grown even more rapidly. Overall, Netflix recently announced that it was upping its spending on content from $8bn a year to $12bn. The reason for this extra spending is down to increased competition. Having seen the huge demand for all-you-can-watch streaming services, Amazon, Disney and Apple are investing in their own versions of Netflix. In Amazon's case this involves allocating $5bn a year for creating content on Amazon Prime, while Disney has said it is pulling most of its content from Netflix in order to host it on its own service, Disney+. What's more, Netflix will lose the rights to stream Friends, its most popular show, when it moves to HBO Max, which will launch next spring.

All this illustrates that in the fast-moving world of technology, being first doesn't necessarily mean that you will maintain your position. After all, few people use Netscape to browse the web, work on a computer that is manufactured by IBM, or use MySpace or Friends Reunited. I therefore suggest that you sell Netflix short at the current price of $310, covering your position if it rises past $390. At £12 per $1 (compared with IG Index's minimum of £4 per $1), this gives you a maximum downside of £960.

Trading techniques: value with momentum

Momentum investing, buying the top-performing shares over a certain period (usually the past three, six ,or 12 months) is a popular strategy, although it can be extremely volatile. At the same time, other investors are fans of value investing, buying "cheap" shares that have low price/earnings or price/book (net assets) ratios.

However, both strategies have flaws. While the evidence suggests that value investing produces higher long-term returns, it can fall in and out of favour (witness its poor performance over the past decade) and can involve holding shares for long periods, something that sits badly with many traders.

However, some investors like to combine the two strategies by buying cheap shares that have risen rapidly over a short time. The logic is that value investors rely on the fact that the market will eventually rate their shares more positively (otherwise there would be no point to value investing). Similarly, adding value criteria helps momentum investors avoid falling into the trap of buying a load of overvalued junk, simply because it's temporarily in fashion.

One person who has extensively tested the performance of such a "value momentum" approach is writer James O'Shaughnessy. He ranked all the listed US shares by value criteria, took the top 10%, and then picked the best 25 performers over six months.

The approach proved successful. He found that the portfolio would have returned an average of 21.2% between the start of 1964 and the end of 2009, compared with 17.3% for value shares and 11.2% for all shares.

How my tips have fared

This has been a mixed fortnight for my current tips, though the wins have eclipsed the losses. Half of the six long positions have risen and the other half have declined. John Laing Group went up from 378p to 381p, JD Sports rose from 604p to 618p and Bellway has risen from to 2,728p to 2,895p.

However, Hays fell from 157p to 147p, Safestore declined from 643p to 637p and Superdry slipped from 447p to 426p. With the gains, especially those on Bellway, outweighing the losses, my long tips are now making a net profit of £1,076, an impressive rise from £572 a fortnight ago.

At present Zoom Video Communications and Beyond Meat are still above the level at which I suggested you start shorting them, which means that I have five open short tips: Weis Markets, Just Eat, Tesla, Pinterest and bitcoin.

Weis fell from $36.49 to $35.61, while Pinterest has declined from $26.72 to $25. However, Just Eat has risen from 633p to 642p, Tesla has gone up from $230 to $257, while bitcoin, which was triggered when it fell below $10,000, has rallied to $10,252.

The upshot is that my short tips are making a net profit of £893, which is slightly down from £918 two weeks ago.Taking into account my Netflix short, I have a total of 12 open tips, six longs and six shorts. This marks the first time in several months that I've had an equal number of long and short tips.

I'm going to give my long tip in Hays one more chance, though I will close it down if it doesn't become profitable. I'm also going to keep a close eye on my long-standing long tip John Laing Group and Weis Markets, the short position, although as both recommendations are in the black, I won't shut them down. Otherwise, I am making no further changes for now.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri