Image source: Getty Images.
Continue Reading Below
Two billionaire hedge fund managers, Andreas Halvorsen and Chase Coleman III, tuned out of Netflix(NASDAQ: NFLX) in the second quarter, selling nearly 20 million shares for a minimum total consideration in excess of $1.67 billion. Coleman alone sold 18 million shares, exiting his Netflix position entirely.
Halvorsen (Viking Global Investors) and Coleman (Tiger Global Management) are both "Tiger cubs", having cut their teeth at Tiger Management, the hedge fund of legendary value investor Julian Robertson, who ultimately seeded their new firms. These are people who deserve the often-abused designation "smart money".
So if you are a shareholder, should you be selling, too?
First, it's worth emphasizing that one should never sell shares based only on the actions of another investor, no matter how famous or successful. There are all kinds of reasons a professional investor might sell a stock -- many of which have nothing at all to do with the company's long-term prospects. Tracking the actions of "Superinvestors" (to use Warren Buffett's term) can, however, provide useful opportunities to review one's investing thesis to verify that it's still on track.
In 2015, Netflix shares gained 138%, the top performer in the S&P 500, but this year the company has struggled mightily. The second quarter started out on a positive note, but upon the release of first quarter earnings, the stock suffered a 13% one-day loss. A similar pattern played out at the start of the current quarter.
What's the story?
Netflix is a "story stock" for an industry-leading company that promises to offer streaming movies and series, acquired and developed internally, to a worldwide audience. While the company continues to face stiff competition,I see no evidence that its fundamental story has changed. Indeed, the company launched in 130 new markets earlier this year.
However, the last two earnings reports have disappointed with regard to user growth. On April 19, Netflix said it expected to add 2 million international subscribers in the second quarter, which was down about 15% from the year-ago period. Three months later, the actual growth only came in at 1.5 million.
Not surprisingly, the market adjusted its expected growth path for the company lower. That raised questions concerning another story -- that Netflix is a growth stock. With shares valued at a trailing price-to-earnings multiple of over 500 times going into 2016, there was no room for doubt or disappointment concerning the company's ability to deliver growth.
Should you sell?
For this value investor, the stock still looks too expensive. For reference, Professor Aswath Damodaran of New York University, an expert on valuation, valued the shares at $61.44 in February, assuming 20% revenue growth and a target profit margin of 25%. That figure is more than a third lower than Thursday's $97.34 closing price.
However, my judgement is a reflection of my personal approach to investing, which is to be skeptical of story stocks and the sky-high valuations they attract. That attitude lets me avoid plenty of flameouts, but I have also missed out on some huge growth stories (I thought Google looked overvalued at its initial public offering, after all). If you were comfortable owning the shares six months ago, it's my belief that you can continue to hold them today -- assuming you have an investor's time horizon, i.e. three to five years, at a very minimum.
User growth rates, like the stock price, can be volatile from quarter to quarter. However, as a very satisfied customer of Netflix, I think its service offering remains attractive: movies and television series on demand, available on a smart, user-friendly platform, at a very affordable price. It's not a difficult concept, but Netflix has applied time and effort to build a customer-oriented culture that gets it right.
Furthermore, with Netflix's successful transition to original content producer, I think the service is as compelling today as it has ever been. Netflix "Originals" are a significant addition to the company's economic moat. As CEO Reed Hastings put it in July, "We apologize for the volatility ... The big picture is very much intact."
A secret billion-dollar stock opportunity The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.
Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.