How Netflix Beat Out Best Buy to Lead the S&P Higher


So far this year, the stock market has raced higher without nearly any interruption. Less than three months into 2013, the S&P 500 is already up more than 9% year to date, and that excludes the additional returns that dividends have provided.

But some stocks have produced much better returns than the overall S&P. In particular, Netflix and Best Buy are battling it out for top honors among S&P 500 stocks, and Netflix currently maintains a small lead, with a 96% return versus Best Buy's 94%. Let's look at what these companies have done to generate those gains and whether they can sustain their strong returns throughout the rest of 2013 and beyond.

How Netflix soared higher
Part of the reason Netflix has risen as much as it has is that it sank so far in 2012. Following its initial miscues in separating its streaming and DVD businesses back in 2011, Netflix shares suffered throughout most of last year as concerns about the potential for rising content costs and the entry of other players into the streaming market weighed on investor sentiment.

Netflix's January earnings report put a stop to the concerns that skeptics had about growth. Producing a profit rather than an expected loss, Netflix has managed to hold on to more of its DVD customers than the company itself had expected, and subscriber counts have continued to rise sharply even in the mature domestic market. Combined with the huge potential from its recent international expansions, Netflix has returned to the high-growth path that shareholders had thought was gone forever, and investors have bid the stock back up to the stratospheric valuations it had two years ago.

Not everyone agrees that Netflix deserves its current valuation, though. With competition from , Netflix will have to deal with the margin-killing power of Amazon's overall business strategy, which generally involves sacrificing current profits in the pursuit of long-term market-share dominance. Although it has so far failed to make a big dent in Netflix's business, Amazon is slowly starting to amass a collection of content that could eventually make things difficult for Netflix.

For now, though, Netflix is riding the wave of good news. It will have to sustain its faster pace of growth to advance from here, but plenty of shareholders still remember the good old days when shares were priced at $300 -- more than 60% higher than their current levels.

Is Best Buy a best-buy?
Meanwhile, Best Buy has gone from the endangered-company list to a market darling in the space of just a few months. Quarterly results from earlier this month allowed investors to breathe easier, as earnings topped estimates handily, and the big-box electronics retailer managed to eke out a small gain in revenue. With CEO Hubert Joly's game plan to turn around the company apparently picking up steam, investors are excited about the prospects of Best Buy's continuation as a public company -- a big change from the recent past, when the possibility that founder Richard Schulze would charge in to take the company private seemed like the only way shareholders could exit their positions favorably.

Yet despite its rebound, many investors still aren't convinced that Best Buy can ever regain its former glory. To win back business from Amazon, Best Buy had to extend a price-matching guarantee to cover the online retailer and other Internet-based competitors. For Best Buy, that means accepting the handicap that the massive costs of having an extensive network of physical stores impose, yet somehow finding the capacity to allow already-thin margins to shrink further so as to meet its obligations to match prices.

Best Buy's best chance is to cash in on the fact that most people want service for their electronics and are willing to pay for it. The company's Geek Squad broke ground on an innovative service offering, and as electronics continue to get more sophisticated, finding more ways to cash in on that niche could eventually justify Best Buy's recovery.

Will Netflix stay ahead of Best Buy?
Between these two companies, Netflix has the longer glide-path to future growth, if only because it hasn't yet tapped into the full international potential of its business model. For Best Buy to keep up, it will need to find more ways to go beyond its weakening core retail business and find profit-producing niches that can generate rising profits in the future. Given how tough a task that will be, I think Netflix has the upper hand in sustaining its lead for the rest of 2013.

Find out more about how Netflix has come back from the brink of disaster by reading our premium research report on Netflix. Inside, you'll learn about how Netflix can fend off its competitors and win in the battle for streaming-video supremacy. You'll also find out about the key opportunities and risks facing the company, as well as reasons to buy or sell the stock. The report includes a full year of updates to cover critical new developments, so make sure to click here and claim a copy today.

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Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter: @DanCaplinger. The Motley Fool recommends and owns shares of and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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