Netflix is being added to the S&P 500. This is an unbelievable story if you look back a years. One of my better equity trades was taking advantage of a short squeeze on Netflix.
I remember in the early to mid 2000s, Blockbuster Video had a deep and loyal client base that analysts thought they could not be touched. Because of this bias in the media, Netflix had over 88% short interest! That means that for every 8 shares held by the public, 7 had been borrowed by short sellers to sell short. You can see the same thing in the below graphic:
When the trend turned higher, and the short interest didn’t decrease, I knew that the shorts were going to bleed through the teeth if there were any positive earnings announcements. Those of you who traded NFLX know what happened next. The know-it-all shorts thought that they knew more than the market and didn’t follow the price.
As new highs were being made, new and existing shorts kept placing their protective buy stop orders above the market. When you’re short, higher prices hurt. In order to minimize losses, traders can place what are called buy “stop orders” at a specific price above the prevailing market. When you’re short, you buy it back to offset the position. Stop orders become market orders when the security trades at or through the stop price that you choose. You can use stop orders to minimize losses, but also to protect gains. That’s why I don’t call them “stop losses” as some incorrectly do because they are “stop gains” when used to protect profits.
The longs wanted more of a good thing and kept buying, triggering these orders. As you might imagine, with 7 out of 8 shares in the public, there was a lot of buying to do by the shorts in order to offset their positions. Valuation can fall more rapidly than price, so that’s not to be trusted either for all the Buffett fans reading. Saying Value Investing is best is like telling a Catholic to convert to Judaism because it’s better.
The earnings announcement came in and it was like 10 cents better than expected during this time. The stock was up $7 in the pre-market and I think it was up somewhere between $9 or $11 by the close. I remember selling it during the day before lunch. When the market gives you a gift, you take it. I’ll have more about this in my book.
You’ll see stories in the paper about deals that Netflix is going to have to close in order to stay competitive. I remember when everyone counted them out and Netflix ate everyone’s lunch. Be wary of analyst’s predictions. Many of the analysts have massive conflicts because they advise the big media companies, and not Netflix. They have a vested (short) interest in seeing the firm due badly or lose market cap as if that will cause doubt in the investors’ eyes. It won’t. Prices fluctuate because they fluctuate, but don’t fight the tape in a downtrend.
The moral of the story: you can trust any analyst you want, but the price always tells the truth.