Netflix and the Media Stock Meltdown By Colin Cieszynski, CFA, CMT, CFTe, Chief Market Strategist, CMC Markets This week, many of the major media companies have sold off steeply as traders reacted negatively to their earnings reports. In particular, softer than expected sales have overshadowed better than expected earnings. The negative impact of the stronger USD Dollar and the potential loss of subscribers from traditional media sources to streaming services such as Netflix, appears to have really spooked traders this week. Two days ago, the negative reaction to Walt Disney’s earnings report sparked a sector wide selloff that continued today with Viacom and 21st Century Fox taking the biggest hits. The chart below shows how Disney broke its 50-day average and has been falling toward its 200-day average. Looking at the performance of the group over the last year, the chart below shows how Netflix has gone from underperforming the sector through the last part of 2015, to increasingly outperforming through 2015. The big question, now, however, is whether Netflix can continue to outperform, or if it could potentially fall back to Earth. Over the last week, while traditional media stocks have been tumbling, Netflix has been on a roll, rising over 13% while many of its more established competitors have posted losses of 10% or more. An old adage of the market is that valuation is related to growth and that high multiples can be supported by high growth rates (as long as they last). One measure that can be used to compare valuation and growth is the P/E to earnings growth ratio, the last line on the table. Most of the majors in the sector studies have a ratio between 0.5 and 2.0 (with 1.0 being the par level) while Netflix has a ratio above 14. In other words, Netflix shares appear to be very expensive relative to other companies in its group and potentially vulnerable. This means that it really needs to keep up its growth to justify its share price but could be in trouble if the company stumbles. Last quarter, Netflix only met expectations on sales and missed on earnings but that was ignored by the street in favour of its growth potential, making it increasingly vulnerable if the company ever fails to meet very inflated expectations. NetFlix shares may already be close to reaching their limits. The daily chart below shows that although the shares have continued to make new highs since April, these have not been confirmed by the RSI indicator. A growing negative divergence reflects slowing upward momentum. Also, in the last few weeks, the shares have moved above their longer term rising channel suggesting they may be getting ahead of themselves. The short term chart below also suggests the shares may be getting tired. After a gap up through $120.00 earlier in the week, the shares have been consolidating between $122.00 and $129.00, unable to proceed much further. An overbought RSI suggests the shares may be due for a pause and a correction possible If the shares fail to hold above the circle $120.00 to $122.00 support zone, a correction would be underway that could drop back to retest the former channel resistance line near $113.00. A gap through the circled zone would create an island top and potentially trap some of the bulls offside. Netflix shares have had a strong run in recent months on growing speculation that the service could eat its competitors’ lunch. They have reached a point, however, where they appear to be getting really overheated increasing the potential that inflated valuations and expectations could come back to haunt them. CMC Markets is an execution only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.