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Netflix Will Suffer an Earnings Letdown

Netflix (NFLX) reports second quarter earnings on July 24. And to keep up its breakneck momentum, Netflix earnings had better come in strong again.

But with NFLX stock tacking on roughly 180% gains since January and expectations high, that isn’t likely.

This streaming video giant has soared in part thanks to a short squeeze, as the bears have been proven wrong by the big-time growth in subscribers. Netflix boasted a total of 29.17 million U.S. subscribers at the end of the first quarter — topping HBO and proving that the tech stock remains on the top of the heap when it comes to streaming video.

However, scale is not growth. Real growth could be harder to come by in the future, and expectations might have to painfully adjust to that.

A recent piece in the Wall Street Journal asserts that “building a formidable subscriber base should be a more immediate concern than raising margins,” and that it needs to be more like Amazon (AMZN) than HBO with a focus on people, not profits.

The WSJ was talking about Amazon’s scale in retail as well as its Prime service that offers streaming video to subscribers. The idea is to scoop up consumers and make them believers in your product, then worry about margins later. It seems a wise piece of advice considering competitors including Hulu and subscription-based YouTube programming from Google (GOOG), among others, are gaining steam.

And don’t forget that entrenched cable companies like Comcast (CMCSA) and Time Warner Cable (TWC) are not thrilled about losing their cash cows and will look to complicate matters wherever they can … including building out on-demand video and offering packages with streaming and cable together.

But while it makes long-term sense to chase subscribers and not profits, investors might not be thrilled to see Netflix cede margins in pursuit of growth. Netflix stock already trades for a forward earnings multiple above 80, and you can only delay the profits for so long.

In fact, part of the reason for a big gap up in April was that Netflix announced a surprise profit — not just subscriber growth. Investors could be banking on that trend continuing.

Well, some investors, anyway. A few weeks back, analysts at Bernstein Research warned that Netflix was overbought, and gave the stock an “underperform” rating with expectations that the stock will slump from more than its current price of roughly $260 a share to $180 in the next year thanks to overly optimistic expectations crashing back to earth.

We could see the beginning of trouble in the latest Netflix earnings report next week.

Of course, with roughly 17% of the float in Netflix held short, there also is a chance a mild beat could result in another squeeze that pushes NFLX even higher. So tread carefully.

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Jeff Reeves is the editor of and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at 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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