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Netflix Stock Is About to Become a Horror Show

Netflix (NFLX) has had a hell of a run in 2013, up over 170% year-to-date on big earnings results and short squeezes.

But that run for Netflix stock might end in tears, and soon.

For the record, I am a believer in Netflix stock as an investor and Netflix the company as a consumer since I subscribe to their service. I just don’t think NFLX can keep up with expectations game.

Here’s why:

  • The forward P/E of Netflix stock is about 75 right now.
  • Short interest remains elevated even after all the squeezes in 2013, with about 16% of the float in Netflix stock held by short sellers.
  • Robert W. Baird just initiated coverage on with a “neutral” rating and a $263 target (about 3% higher), hinting that Wall Street is getting wary.
  • Competition is fierce from Amazon (AMZN) and its fast-growing Prime service, Google (GOOG) with its Chromecast and even Intel (INTC) as it gets into the Internet cable scene.
  • International growth remains a big investment, even though the profits haven’t materialized. Spending will have to result in an earnings bump eventually … and stick.

Sure, price-to-earnings valuations are frequently meaningless for fast-moving tech stocks — just look at Amazon and its sustained nosebleed P/E as proof. And sure, the short-sellers have been proven wrong repeatedly in 2013 and that has in part sparked the massive run-up in Netflix stock.

But the risks are big.

Wedbush Securities analyst Michael Pachter said in late July that the stock could fall to about $200 in the second half of the year as sentiment shifts.

Furthermore, a long-term risk is that “(v)alue inevitably migrates to the original rights owner,” as Matt Yglesias of Slate writes, and that Netflix is going to have to create its own great content to compete. Thus far, House of Cards and Orange is the New Black have won over critics … but two shows does not make Netflix the new HBO just yet.

And the high price of acquiring content — such as the late 2012 deal with Disney (DIS) — seems to only spiral higher, squeezing margins and complicating growth. And then there’s the risk of a competitor poaching programming like Amazon has done with Viacom (VIAB) properties like hit kids show Dora the Explorer and other Nickelodeon titles.

Look, Netflix stock isn’t going to disappear. But it’s naive to think that these big risks, tied up with overly rosy sentiment and significant short selling, won’t result in some kind of headache for Netflix investors.

And given the frothy 170% run in Netflix stock across 2013, it’s reasonable to expect at least a short-term pullback soon. Shares lost about 12% in two weeks across late May before snapping back in July, so NFLX has already shown us that volatility works both ways.

Netflix stock investors should take note.

I love the Netflix experience as a consumer, and haven’t had cable for years in part because of the value NFLX brings me. But Netflix stock doesn’t live and die based on my viewing habits.

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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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