Netflix, Inc. (NASDAQ:NFLX) is a darling of growth investors these days, and with a rising share price that made it the best S&P 500 performer this year, it’s hard to blame them.
At the same time, it appears the company’s recently released first-quarter results missed expectation, and as a result, shares are lower in the wake of the report.
Despite a wildly popular service with millions of satisfied customers, Netflix, Inc. (NASDAQ:NFLX)’s earnings report and corresponding stock decline serve as a reminder of what so often happens when a skyrocketing stock price meets irrational expectations.
When valuation and rising expectations collide
Many investors may be scratching their heads in the aftermath of the company’s earnings results. It’s not entirely unreasonable to be confused, because on the surface, 20% revenue growth and quadrupled year-over-year earnings per share look outstanding. Most companies would love to boast that type of growth.
Unfortunately, this is yet another occasion when investors are rudely reminded of the crucial importance of valuation. Netflix had been on fire over this past year, soaring from $92 per share at the beginning of 2013 to its recent high of nearly $270 per share. Its valuation, and consequently future expectations, rose along with its share price.
That’s why investors shouldn’t be surprised that the stock slumped after hours, even with the impressive underlying results. This is how Wall Street expectations often unfold: institutional investors fall in love with a company, then send the stock, along with their future expectations, to unsustainable levels.
Netflix, Inc. (NASDAQ:NFLX) added 630,000 streaming customers in the United States? Too bad—analysts wanted 700,000.
Ignore valuation at your own risk
To be fair, Netflix isn’t the only stock on a huge uptrend that has placed its investors teetering atop dangerously high expectations. Social media site LinkedIn Corp (NYSE:LNKD) exchanged hands for $93 per share after its heavily publicized 2011 initial public offering. Since then, the stock has gone on a nearly uninterrupted run to $200 per share.
This came right alongside dramatic increases in users and revenue. As of the company’s last quarterly results, the website boasted more than 225 million members. Moreover, LinkedIn booked 72% revenue growth in the first quarter, year over year.
LinkedIn Corp (NYSE:LNKD) also generated huge growth in full-year 2012, with revenues and diluted EPS skyrocketing 86% and 72%, respectively. That being said, LinkedIn amassed a grand total of $0.19 per share in diluted earnings. That means that investors are paying more than 1,000 times 2012 earnings.
Online retailing juggernaut Amazon.com, Inc. (NASDAQ:AMZN) is adored by millions and has an incredible growth story. The company has grown to a market value of nearly $140 billion and its shares trade for more than $300 per share, up from $250 per share at the start of the year. Amazon’s sales have grown at an amazing clip. To illustrate, consider that Amazon racked up 27% sales growth last year.
However, despite a stunningly large market value and huge revenue growth, Amazon is not consistently profitable. Amazon lost money last year, despite racking up $63 billion in sales.