Downgrading a Holding That’s Increasingly Hard to Defend

We are understandably getting questions about Netflix (NFLX) given the continued slide in the stock price and it have now moving past the Pro Portfolio’s checkpoint level. To be blunt, this position has become increasingly difficult to defend, especially after CEO Ted Sarandos commented the company isn’t growing as fast as he would like. That suggests we could see some resetting of consensus expectations, but there are a few other factors that we have to consider as well.

First, tax-loss selling. With the gains we’ve seen in other parts of Tech, and I’m talking about the ones that have helped the Portfolio keep its year-to-date lead over the S&P 500, folks will be looking to minimize tax implications for any short-term gains they’ve booked. In our view, the renewed pressure on NFLX shares makes them a candidate.

Second, more than likely the upcoming Anthropic IPO and its potential to re-open the IPO window means investors that partake in IPO transactions will be looking to raise cash in order to participate.

Third, it appears that Google’s (GOOGL) YouTube has become an interested buyer in live sports for almost all of the major U.S. sports leagues if it can get bespoke rights. This adds another potential layer to content costs in an area that Netflix is aiming to participate. Of the companies reported $20 billion content budget, around 5% is for live events.

However, one could argue that considering where NFLX shares are trading, at least some of those issues are already baked into the share price, which is once again encroaching on an oversold condition.

For us and our $86.30 cost basis, the question is this: What’s the catalyst to drive the shares back above that cost-basis level? Complicating that answer, as we see in the chart above, the shares have a three-pronged layer of technical resistance ahead of them. This suggest that it will take a pronounced development to pop the stock and get it back on a positive trajectory.

Possible, but the probability of that happening is waning, and there are more compelling places to put capital to work.

Our Rating Downgrade and Its Rationale

As we have long said, hopium is not a suitable strategy for investors. Putting all of the above together is leading us to downgrade Netflix shares to a Three rating. We will look for strength in the shares to start unwinding the position as we move past what has been a seasonally challenging time for the market and into a stronger one. Should we see a compelling investment case elsewhere or signs the market is poised to soften, NFLX shares will be considered a likely source of funds.

Why not cut to the chase and downgrade to a Four rating? Our reason behind not going straight to that rating and starting to unload the shares today is two-fold. First, the shares are re-entering an oversold condition and that means any positive development could lead to a bounce in the stock. That’s especially the case with more than 94 million shares short as of September 15, per data from Nasdaq. The number of days to cover? Almost 3.6.

Second, we want to flag the change in our view on the shares to those who track the Portfolio closely, telegraph our intentions and avoid any surprise when the time comes to start unloading the shares.

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At the time of publication, TheStreet Pro Portfolio was long GOOGL and NFLX.