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I Was Dead Wrong on Netflix

Back in December, when Netflix (NASDAQ:NFLX) was under $100 a share, I penned a column about how the stock seemed overvalued despite analyst upgrades and strong earnings.

Now that NFLX is at $225, it’s time to admit that was a bad call.

In my defense, I did a bit of an about-face and more recently wrote that Netflix might move big after earnings in April … and it’s up 40% since then. But now I’m ready to move beyond a swing trade and admit that Netflix is legit, and that this stock might have some serious upside potential beyond just earnings beats and short squeezes.

My previous concerns included common complaints among the bears. It went a little something like this:

  • The forward P/E is insanely high, even for a high-growth tech stock.
  • Brand tarnish after the Qwikster debacle.
  • International growth is burning cash but not generating profits.
  • The big spending on programming, both in-house and partner content, is a gamble.
  • Competition — Amazon (NASDAQ:AMZN) Prime, subscription-based YouTube programming from Google (NASDAQ:GOOG) and Hulu Plus, among others — is going to eat into Netflix market share.

While some of these concerns are still valid, it hasn’t held back Netflix at all — nor has it affected the company’s impressive string of recent earnings beats.

Netflix stock exploded after strong earnings in January, squeezing out the shorts and tacking on some 70% in just a few days. NFLX surged because it posted an unexpected Q4 profit thanks to an influx of 2 million U.S. subscribers and another 1.8 million folks added internationally.

But that wasn’t enough — the company reported Q1 earnings in April that beat forecasts handily and resulted in another big pop for shares. Netflix topped $1 billion in revenue for the first time, and topped 30 million domestic subscribers.

This stock is for real, folks.

Does that mean you should run out and buy Netflix stock? No — I think that the meteoric run of 2013 has to cool off a bit, so don’t buy a top here. A lot of the gains were made by short-sellers buying because they had to cover their positions, and you have to admit that some profit-taking is likely after this big run.

Netflix had about 10 million shares held short as of April 30 — or 25% of available shares for trading. That’s after two huge earnings beats in three months that squeezed out other bears. And back in early November, there were some 17 million shares held short, or roughly 34% of the available shares.

In other words, 7 million shares were bought by short-sellers who threw in the towel over the last six months or so. There assuredly were people going long on the stock, but it seems to me that there aren’t that many buyers left right now.

Thus, I think sellers have the upper hand in the short-term, but after the inevitable dip — maybe back to under $200 or so — it might be time to ride this streaming video powerhouse.

The risks for Netflix remain, but the stock has proven itself to have staying power. While shares are frothy and I think a pullback is likely, you might want to consider staking out a position in NFLX.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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