I Was Wrong to Trust This CEO


I remember it like it was yesterday.

The date: April 26, 2011. The place: the Fool's MarketFoolery podcast. The subject: Netflix's (NAS: NFLX) earnings.

I was forced to learn from my mistakes the hard way. I blindly followed CEO Reed Hastings without critically examining what was going on in his industry.

Read on, dear Fool, so you don't make the same mistake I did.

An unexamined warning
Back to that infamous podcast. The first subject our Foolish team covered was the recent earnings announcement from Netflix, and Fool analyst Charly Travers didn't mince words when it came to what he thought:

I'm not happy with what Netflix is doing. This company is wasting gobs and gobs of money at a time when their business is under assault from all angles. ... It's inconceivable that buying back stock at 80 times earnings is better than investing in content that's going to attract new subscribers.

Silly Charly! Didn't he know that Netflix had been defying conventional wisdom for more than a decade? Didn't he know that, against all odds, it had eliminated Blockbuster, driving it into bankruptcy? And, most importantly, didn't he know what that the company's chart looked like?

Netflix Stock Chart
Netflix Stock Chart

Netflix Stock Chart by YCharts

"Surely, Charly's just one of those curmudgeon value investors who isn't hip with the new times," I told myself. And so I continued, blindly trusting that Hastings could walk on water.

Sorry excuses
This is a cautionary tale for those who think "buy and forget" is a solid investment strategy.

When I originally purchased shares of Netflix, streaming was just a peripheral offering. I knew the company had the infrastructure in place to defeat even the likes of Wal-Mart (NYS: WMT) : It had DVD-distribution centers located right next to post offices to ensure speedy delivery. That delivery, along with excellent customer service, had helped the company's subscriber count snowball as time went on.

Though I knew through my own experience that streaming was becoming a bigger and bigger deal, I spent my time researching new stock ideas, and I never dug very deep into what this would mean for Netflix.

As a result, I missed that its relatively low level of cash on the balance sheet opened it up to serious threats from the likes of Amazon.com (NAS: AMZN) , Google, Apple, and DISH Network (NAS: DISH) . Without more cash on hand, Netflix would have trouble signing the expensive content deals that studios were now demanding -- demands that its better-funded competitors could easily meet.

Chickens coming home to roost
I'm embarrassed to say that it was the price increase -- not the obvious misuse of cash -- that really caught my attention this summer. I wrote an open letter to Hastings, asking him to explain himself. Surprisingly, he did, and I pretty much left it at that, satisfied with his response.

My real mistake was that once the stock's price fell to around $240, I decided to buy more. Though hindsight is always 20/20, I'd like to believe that had I taken a harder look at the situation,and not blown off the warnings Charly had offered up months earlier, I could have avoided my increased exposure to this summer's string of PR debacles. Of course, last week's announcement that the company will dilute shares in an effort to shore up cash was just salt in the wound.

How I'm now approaching Netflix
I certainly don't regret holding on to my original shares that I purchased a few years back. I believe owning shares is akin to owning a living, breathing company. I do, however, very much regret buying more shares at the $240 price point withoutdoing my homework. It's an embarrassing, but valuable, lesson to learn.

Though Netflix has surely stumbled, and badly, I do believe that Hastings is an intelligent man. It takes some gumption to man up and cancel Qwikster as soon as you've started it. At today's prices, I think there's a lot of upside considering Netflix's potential for international expansion. I won't be buying more shares, but I won't be selling, either. That's why, though it's losing to the market by more than 50 points, I'll be leaving my green thumb on Netflix open moving forward.

Have your own lessons learned from investing mistakes? Let us know about them below. And don't forget to add Netflix and its competitors to your watchlist to avoid making the same mistakes I did.

At the time thisarticle was published Fool contributorBrian Stoffelowns shares of Netflix, Google, Amazon and Apple. You can follow him on Twitter at@TMFStoffel.The Motley Fool owns shares of Apple, Wal-Mart Stores, and Google.Motley Fool newsletter serviceshave recommended buying shares of Google, Netflix, Apple, Wal-Mart Stores, and Amazon.com, creating a bull call spread position in Apple, and creating a diagonal call position in Wal-Mart Stores. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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