MARKET OVERVIEW 

Two weeks ago we closed this column by saying, “We believe there will be several stocks experiencing significant changes in value later this month, and we want you to be ready to profit from them.”  Since then some early earnings reports have started to trickle out, with a barrage of many more hitting the street over the next several weeks so we think that time is now upon us.

Later today Apple (NasdaqGS: AAPL) will report earnings, and the expectation is that they will be better than originally anticipated.  As I write this at 11 a.m. the stock is up more than 1% while the Nasdaq Composite Index is down .5%.  In last month’s issue of Smart Tech Investor we named Apple “The  One Tech Stock to Own in 2014”, and nothing we have seen so far has dissuaded us from that opinion. 

In short, we feel the stock market as a whole – and the tech sector in particular – is on the cusp of a major revaluation that will result in the type of two-tiered market that creates many lucrative trading opportunities for bulls and bears alike. If you have not done so already, please review the summaries of our Investments Portfolio and Equity Trades Portfolio provided in the past two issues of this publication (tables below).

As you hopefully know by now, our thesis on tech stocks is that the long term winners will be those companies that have correctly identified the eventual endpoints of technology convergence, and are aggressively investing capital in innogration to stake out a spot as a market leader in one or more of those categories (and if you aren’t familiar with this concept, please take the time to read our special report “Hot Tech Stocks for Smart Investors” under the ‘Resources’ tab of the STI website).

As earnings season unfolds over the coming weeks, we will begin to see the early signs of realization in the market that some companies will be able to maintain earnings growth in the face of Fed tapering, while others will struggle.  Out system is designed to identify those long term winners well before the rest of the market does, and as this year progresses we expect to see the companies recommended in our Investments Portfolio rise to the top.

Nasdaq Composite Index:

Friday, January 24 = 4,128.17

Trailing 7 Days = -1.7%

Trailing 30 Days = 0.0%

Year-to-date= -0.4% 

PORTFOLIO UPDATE

Already, most of the short sell recommendations in our Equity Trades Portfolio are beginning to pay off, as most of them have by now crested above our Sell Limit thresholds and are now falling back down beneath them.  If you sold any of them short and/or bought puts on them based on our advice, then you should already be seeing some profits.

For example, earlier this month 3D Systems (NYSE: DDD) peaked at $96 – well above our sell limit target of $80 – but has fallen dramatically (losing another $5 in trading this morning) to less than $75. 

And Amazon.com (NasdaqGS: AMZN) traded as high as $407 just last week – slightly above our Sell Limit target of $390 – but is now below that threshold and appears to be fading rapidly. They report earnings later this week (January 30^th) so keep a close eye on that one.  If the Christmas sales numbers are anything less than outstanding we could see a fairly major exodus from the stock.

Even Facebook (NasdaqGS: FB) is starting to lose momentum, topping out above $58 a few days ago but now below our Short Sell threshold price of $55.  They report earnings this Wednesday afternoon, and it looks like a lot of investors aren’t expecting good news. 

As Warren Buffett once famously observed, “only when the tide goes out do you discover who’s been swimming naked.”  And so far three of our four short sell recommendations are starting to show signs of little clothing now that the receding tide of earnings season is upon us.  However, the fourth member of our quartet has been trading in a most unusual manner and is worthy of deeper scrutiny as we are not sure if it is really wearing a bathing suit or is just hiding it well.

Netflix (NasdaqGS: NFLIX) is the fourth member of our original quartet of short sell recommendations in our Equity Trades portfolio, and until last week was behaving exactly as we expected.  We initially placed a Short Sell limit price of $360 on it back in December, and shortly thereafter it peaked at $380 before making a precipitous drop down to $330. 

In fact, in last week’s edition of this publication we warned that it was too late to get in on the Netflix short sell given its rapid descent, but three days later it shot back up above $380 after announcing much stronger than expected earnings results for the fourth quarter of 2014.  In other words, in the span of six weeks we are essentially right back to where we started with this stock.  So, what to do now?

There is a tremendous amount of noise surrounding Netflix these days. On the plus side it is saying its subscriber base is still growing. In addition, Netflix also has a hit show with its series “House of Cards” starring Kevin Spacey. The best case for Netflix would require it to continue creating new exciting television content which would resonate with fans strong enough for them to shell out $84 a year to continue to receive new programming from Netflix.

One might ask why the market is focused on new series programming from Netflix when they also provide streaming access to older movies within their subscription pricing. The reason why few analysts focus on the older content is because the video streaming market is fracturing as more competitors have entered that market space.

As an example, for $79 annually Amazon offers free two-day shipping on most purchases along with video streaming as a part of its Amazon Prime offering. As Amazon beefs up its catalog of existing content the gap between it and Netflix will shrink over time since Netflix is investing in new content production rather than increasing its catalog of older videos.

Hulu Plus offers similar video streaming services; however, their catalog is centered around older TV series. With Amazon and Hulu providing similar streaming services on older video content, the only way for Netflix to grow requires that they offer unique programming.

Earlier in Netflix’s growth model many pundits thought that consumers who were tired of their escalating cable and satellite service provider bills would “cut the cord” and go with Netflix instead. Though some did, both Verizon and AT&T have grown market share in markets where they provide TV programming access, further cutting into Netflix’s potential growth opportunities. 

The problem with unique programming was the central issue which eventually caused the downfall for all the large Hollywood movie studios. It is very difficult to produce interesting new videos as the process is based on two critical factors: first, being able to consistently produce creative and well-done content, and second, having the cash on hand to fund these productions. Actors such as Kevin Spacey don’t work on the cheap; therefore, each new production becomes a bet-the-company type of proposition.

If Netflix were the only company creating new content then we might look more favorably on their stock. However, HBO is taking the same approach in creating new programming such as the very popular “Game of Thrones” and other new series. HBO also provides access to much more recent movies. HBO provides video streaming with their HBO Go offering. Its prices are more expensive than Netflix but in exchange they provide much newer content.

Where all of this leaves Netflix is fighting for subscriber growth in a market where their competitors have more cash. Netflix is growing its subscriber base, but that is predicated on its one hit series. Once that series concludes, what will differentiate Netflix?

The cost of subscriber acquisition is climbing for Netflix. This is occurring while many customers are not interested in engaging in the complexity of accessing Netflix or Hulu compared to just turning on their TV. They prefer getting their programs via a program guide which all the satellite, cable and companies like Verizon provide – there is much to be said about simplicity.  We don’t foresee this competitive dynamic curtailing anytime soon, if ever.

For those reasons we still believe that Netflix is a long term loser in the video business, and maintain our short sell recommendation on it in our Equity Trades Portfolio.

• Portfolio updated: Thursday, December 19th, 2013 12:46PM

LEGEND:

BiQ = Boeckl Innograton Quotient.  It is a scale from 0 – 10 that reflects the extent to which a company possesses the critical elements of innogration, and includes a score for dividend yield (0 – 3), change in operating cash flow (0 – 3), and innogration strategy (0 – 4).

STR = Smart Tech Rating.  It is the BiQ adjusted by the ratio of a company’s forward twelve months earnings per share multiple (FTM) to the same ratio for its peer group.  For example, a company with a Biq of 5.0 is trading at a FTM of 30 versus an FTM of 15 for its peer group, so its BiQ score would be reduced by 50% (15/30) for an STR of 2.5.

Stop Loss is the price at which a stop loss order should be set to protect you from excess loss in the event a stock does not behave as we anticipate.  For a long or buy position a stop loss order would be set below the current price, and for a short or sell positon a stop loss would be set above the current price.