Momentum stocks are some of the most exciting stocks to invest in. However, they are not for the faint of heart, as they regularly experience huge gains or steep losses.
Companies like Netflix, Inc. (NASDAQ:NFLX) and Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) emerged from the 2008 recession relatively unscathed and grew 10-fold over the next couple of years. Toward the latter half of 2011, they came crashing down and would lose as much as 80% of their value. Then in 2013 they would recover most of the lost ground.
As investors, by focusing on what drives share price; at least it’s possible to make a well-informed investment decision on these high-risk high-reward companies.
I will analyze the prospects of three momentum stocks that have had a great year: Amazon.com, Inc. (NASDAQ:AMZN), Netflix, Inc. (NASDAQ:NFLX), and LinkedIn Corp (NYSE:LNKD). Information on share-price appreciation, forward P/E (price-to-earnings) ratio, and market cap is below.
Netflix’s future subscribers and content risks
Netflix, Inc. (NASDAQ:NFLX)’s subscription-based business model completely changed the video-rental industry. Its success bankrupted Blockbuster, and its introduction of streaming services was revolutionary.
In 2011, due to rising costs, Netflix, Inc. (NASDAQ:NFLX) split its DVD-by-mail and streaming services into separate subscriptions, which caused subscription numbers to plummet. Its stock soon followed suit because even more so than earnings; subscription numbers drive Netflix shares.
This was evident in this past quarter. Despite killing EPS estimates, shares dropped as subscription numbers came in below expectations.
Where Netflix, Inc. (NASDAQ:NFLX) goes from now will be dependent solely on its ability to grow subscribers. Unfortunately, I foresee difficulties reaching lofty subscription goals.
During Netflix, Inc. (NASDAQ:NFLX)’s first-quarter earnings call, CEO Reed Hastings stated that his “Best guess for a market like Netflix is about 60 to 90 million” subscribers.
To reach the higher end of that estimate, nearly every one of the estimated 66 million households with broadband access in the United States would have to start a Netflix, Inc. (NASDAQ:NFLX) subscription.
While there is room to move up if subscription numbers do, I do not like Netflix, Inc. (NASDAQ:NFLX)’s long-term prospects. Even if it succeeds in attracting that many subscribers, it will still have to deal with maintaining a rich content library at a cheap price.
Amazon, the most expensive and second-largest e-commerce company
Amazon.com, Inc. (NASDAQ:AMZN) has been plagued by low profit-margin concerns throughout its existence; however, it has continued to grow and generate massive shareholder returns. Despite operating at razor-thin margins, Amazon’s innovation has lead to its success.
AWS (Amazon Web Services) is Amazon.com, Inc. (NASDAQ:AMZN)’s most successful division. Growth at AWS will be one of the most important drivers for Amazon. AWS recently scored a $600 million dollar contract with the CIA for its cloud storage. It reportedly had better technology than competitors.
However, I believe Amazon.com, Inc. (NASDAQ:AMZN)’s valuation is a big problem. Its market cap is $140 billion. To put that number in perspective, I compare it to Alibaba, which has an expected IPO valuation of $100 billion.
In 2012 Alibaba became the biggest e-commerce company in the world. It handled more transactions than Amazon.com, Inc. (NASDAQ:AMZN)and Ebay combined. In the most recent quarter, Alibaba had earnings of $669 million and a profit margin of 48.4%. In comparison, Amazon had earnings of $82 million and a profit margin under 1%.
How is it one e-commerce company – in a more mature market, with a fraction of the other’s profit margin – can be valued at almost a 40% premium? Future success by AWS will help Amazon.com, Inc. (NASDAQ:AMZN)’s share price appreciate, but long term, Amazon has to show it can make real earnings.