“Like Dell in 1990 … Now is the Time to Get in”

By Travis Johnson, Stock Gumshoe, August 16, 2007

I’m finding that sleuthing out stock picks is a healthy way to indulge in my stock market addiction on days like this, when I would otherwise be throwing money at what look to me like serious bargains, only to watch them fall a further 10 or 20% in the minutes following my purchase.

So in an effort to save my sanity, I’ve been reading another email from the Motley Fool — for those keeping score, that means I’m writing up two in a row for Tom Gardner here at the Gumshoe! This one is for the Motley Fool Stock Advisor newsletter, which is the oldest and, I think, least expensive of the Fool newsletters ($99 on sale a the moment).

The letter, from Stock Advisor’s publisher, promises to identify the latest stock that has a singular, almost-guaranteed-to-win characteristic.

In his words, “while thousands of issues trade on the U.S. markets every day, a GRAND TOTAL OF 19 STOCKS have surfaced with this ONE defining characteristic going back to April 2002 … [and] stocks like this have earned investors average PROFITS of 79.3%”

That sounds halfway decent, no?

And he’s ready to tell us the name of the latest stock to meet this criteria … if we’ll just sign up for our trial subscription (naturally).

“I don’t exaggerate when I say the stock we’re discussing today comes … Closer to being a SURE THING than anything I’ve come across in a very long time. “

The “defining characteristic” that is being teased here is that the stock has been re-recommended by Stock Advisor. These, clearly, are the stocks that the Gardners feel most passionately about — examples given include Quality Systems, which is certainly a nice performance to aspire to over the past few years.

So, what company are we talking about here? We get several clues:

“$65 million in free cash flow annually”

“has nearly $400 million in cash, zero debt, and not so much as a single inventory or accounts receivable cost?”

Growing free cash flow 20% a year.

“Just like Dell in the 1990s, this company is the top-rated consumer brand and undisputed leader in its category — shipping a staggering 1.4 million units per day nationwide.”

They have 6.8 million customers already.

And apparently growth is projected, still: “the company expects to blast through the 10 million subscriber mark within the next two years and to surpass 20 million before 2012”

The company was founded in 1997, and the founder is still at the helm and is a major owner (more than $60 million in stock)

And the key:

“A recent 25% drop in share price makes NOW the time to get in”

So … we insert the relevant data into the Wisdomization Thoughtifier, and find that this company is …

Netflix (NFLX)

I know — quite a letdown, eh? Always sad when you get tantalized by a company that it turns out you already know quite well. And if you’re listening to the Wall Street cognoscenti, you probably hate this one. The shares are down quite a bit more than the “recent 25% drop,” the shares did indeed have a couple 25% drops this year, but overall are down almost 50% from the Winter price near $30, and even down quite a bit from the $20-30 range they’ve traded in for the past two years.

And you probably know the story quite well — Netflix vs. Blockbuster vs. whatever-the-online-movie-delivery-thing-is-going-to-end-up-being. Netflix’s recent decline is because they had their first quarter in memory in which they LOST customers (bringing them from that 6.8 million teased number down to 6.7 million), and they’re losing them to their archrival, Blockbuster, which is offering that “in store trade-in” option for movies that Netflix can’t compete with.

The good news is that Netflix is MUCH stronger financially than Blockbuster — so if this ends up being a protracted price war, Netflix might win.

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But the bad news is, price wars don’t often generate much in the way of sustainable earnings growth, the kind of growth that Netflix enjoyed when they had the subscription movie rental business more or less to themselves, and Blockbuster has the secret weapon of thousands of local stores that they could use to raise cash or generate other revenue streams (their head guy now is, if memory serves, a convenience store veteran who wants to use the stores more effectively). Depending on which analysts or journalists you read, those stores are either Blockbuster’s achilles heel, or their secret weapon … personally, I’m undecided on that dispute.

Netflix has been a Motley Fool favorite for years and years, so you’ll find lots of articles on their site about the company even if you don’t subscribe to the newsletter, if you just want to get a handle on things. Tom Gardner may well be right, it might be that the visionary leader of Netflix will see them through this market turmoil the same way he has in the past, and help to build a stronger company. Netflix certainly has lots of cash, and they’re reportedly spending it to build better delivery systems for if and when online movie rentals become viable for the masses.

The founder, Reed Hastings, is also on the board of Microsoft, so we can be assured that he’s pretty well connected in the industry should he decide to sell to a bigger company (that’s been the rumor for quite some time, whether it’s Microsoft or Amazon or Google or someone else doing the buying).

It’s certainly true that this company developed a new market, and became the market leader by taking some of Blockbuster’s customers … whether you want to bet that they’ll do so again, well, that’s up to you. I’ve looked at NFLX before and always found it too expensive to look into very thoroughly (though I am, personally, a subscriber), but it certainly looks like it might be more appealing at these prices if you’re not scared of price wars. As always, it’s your money so do your research, and let us know whether you think it’s curtains or showtime for Netflix.