More Evidence of the Power of Contrarian Investing

It seems that the only thing traders and investors on TV want to do is try to handicap when a bunch of government officials and bureaucrats in Europe will finally make up their minds and solve the crisis still gripping the region.

But while that may be a fun mental exercise, I prefer to use my time looking for good investments to buy. Because when you find a good investment at a compelling valuation, the implications from Europe or any other crisis can be substantially minimized. On top of that, the rewards can be gigantic!

Take Netflix (NFLX) for example …

NFLX was a darling of Wall Street during much of 2011. That is until the company decided to split its on-line streaming video service and its traditional DVD-by-mail service. In addition, they raised prices on their subscribers.

The customer outrage was incredible, and subscribers cancelled in droves (I was one of them!).

The stock absolutely collapsed, from a high of over $300/share in July, to a low of $62/share in late November, a fall of nearly 80 percent! You would think that given the decline, Netflix was on the brink of going under.

But the company hadn’t lost all of its subscribers. Plus it was trading at a very compelling valuation …

Netflix, at the peak, was trading at 63 times 2011 expected earnings of $4.75/share. At the bottom, it was trading at just 13 times earnings, which was about the same multiple as stodgy, non-growth stocks. At that valuation, there was a valid argument to be made for getting long the shares, even though Wall Street still hated the stock!

Investors who bought in that $60, $70 even $80 dollar range turned out to be right, as shown in the above chart. And last week Netflix’s announcements further confirmed that that had been a smart move …

  • The company reported 21.7 million steaming video subscribers, beating expectations,
  • The company expects to add between 1.1 million and 1.9 million streaming video subscribers next quarter, besting expectations, and
  • The company reported $875 million in revenue for Q4 2011, and over $40 million in net income easily topping Wall Street’s dire expectations.

Buyers who saw the value in this stock have earned a big reward: Shares were up 20 percent in one trading day last week, and hit $125 on Monday, up a jaw-dropping 100 percent from that low in November.

So at this lofty price range, does this mean that Netflix is out of the woods as a business and there’s nothing but higher profits ahead?

Of course not … the valuation is no longer as attractive as it was when shares were at $60.

But the point is that to make money in this market, it’s necessary to look for value in names the Street and the market hate — and try to avoid being obsessed with the latest headlines.

Best wishes,

Tom

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