David Einhorn Has a Right to Be Cynical About Netflix

On July 13, David Einhorn, the highly watched leader of Greenlight Capital, issued his second quarter 2015 letter. Within that letter he highlighted his disdain for streaming service company Netflix Inc. (NASDAQ: NFLX).

Interestingly, he made the following observations: “In today’s market, the best performing stocks are companies with exciting stories where accountability is in the distant future.” And Netflix “transitioned from being a company judged by how much it earns into a company judged by how much it spends.” He definitely has the right to be doubtful of Netflix. Here’s why.

Netflix’s stock growth trajectory now stems from purely a story-driven catalyst, in an Inc. (NASDAQ: AMZN) fashion, where free cash flow generation matters less and the story matters more. For investors, what matters most over the long-term should be free cash flow consistency and growth.

Businesses need to generate cash in an effort to pay bills; otherwise they will need to lean on outside sources to fund operations. Netflix’s free cash flow, while lumpy in the distant past, resided in the negative range since 2012, according to Morningstar. In fact, Netflix’s free cash flow deficit worsened consistently for three years running and for the trailing 12 months.

While it is possible that Netflix will garner some sort of moat over the long-term stemming from market leadership, it is basically a content owner’s game and not a content distributor’s game. If a company like Walt Disney wants to pull its content from any given distributor it can, leaving the distributor holding the bag. The technology exists that a content owner can also be a distributor. Netflix needs to generate more of its own content to create a moat that could translate into more free cash flow over the long term.

ALSO READ: 5 Dividend Stocks That Give You Consistent Raises

Until Netflix produces enough strong original content that viewers can’t resist, its underlying business is up for grabs from competitors and new technology. A Netflix with strong original content to bolster its free cash flow will be one worthy of Wall Street song.

Some Wall Street analysts share some of Einhorn’s cynicism. Thomson/First Call has a mean target price pegged at a split adjusted $92.91 per share, representing a potential 7% decline.

Buffett Missed These Two…

Warren Buffett loves dividend stocks, and has stuffed Berkshire with some of his favorites.

But he overlooked two dividend legends that continue to print checks on a new level, they’re nowhere in his portfolio.

Unlock the two dividend legends Buffett missed in this new free report.

Thank you for reading! Have some feedback for us?
Contact the 24/7 Wall St. editorial team.