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Two major reasons to worry about this FAANG stock



From Austin Root, Portfolio Manager, Stansberry Portfolio Solutions:

It’s an enigma…

Streaming giant Netflix (NFLX) is one of the most compelling growth stories the entertainment industry has ever seen, growing from nothing to a dominant industry force in a little more than a decade… And yet, at the same time, it’s the perfect example of how not to run a business for the long haul.

Following the company is kind of like “binge watching” one of its award-winning programs. Every new quarterly report is fascinating, packed with reasons for both optimism and dread… and the more time I  spend following it, the less sure I am of how things will ultimately end for the stock.

Today, we’ll look at the factors that make Netflix’s earnings the Wall Street equivalent of “must-see TV.” There are many reasons for optimism about Netflix, but three stand out above the rest.

For one, Netflix already disrupted one industry, and it’s now in the process of upending two others…

First, Netflix destroyed the brick-and-mortar video-rental business. You may recall the company’s origin story… Tired of paying late fees to Blockbuster when he didn’t return movies on time, Reed Hastings founded Netflix, which got its start by mailing you DVDs that you could keep for as long as you wanted.

But in 2007, Netflix turned its focus from physical DVDs to streaming over the Internet, and the company took on a much larger industry: cable TV. Not surprisingly, at about the same time, growth in the total number of pay-TV subscribers in the U.S. began to slow. By 2016, pay-TV subscriber counts had flatlined. Today, they’re in freefall. It turns out, $11 a month for unlimited access to countless shows and movies beats spending $70 (or more) a month for limited access to far less content.

In 2013, when Netflix began to create its own original content, it took aim even higher up the media industry food chain by going after the movie and TV studios themselves. This meant that traditional media-content companies like Disney (DIS), Sony (SNE), Comcast’s (CMCSA) NBCUniversal, and AT&T’s (T) Time Warner saw one of their highest-paying customers become the competition. It’s still not clear how this will turn out, but the old-guard media titans don’t like it one bit.

Second, Netflix is huge and still growing like a weed…

In 2010, Wall Street marveled that Netflix grew to 20 million total subscribers. As of this past September, the company had nearly 140 million subscribers, growing by almost 20 million in the first nine months of 2018. For the past 10 years, Netflix has grown its user base by more than 30% per year on average.

Today, Netflix accounts for an astounding one-third of Internet traffic in the U.S. during peak usage times. And while Hastings anticipates domestic growth will slow, international growth is just getting started – and has actually accelerated in recent months. That means Netflix’s subscriber base should continue to grow rapidly for many years to come.

Finally, Netflix has incredible pricing power…

Consumers are streaming a lot of Netflix content, and that means the company can increase its prices with virtually no long-term effect on subscriber retention or growth.

As I noted earlier, the standard Netflix plan costs $11 a month, compared with the average cable-TV subscription, which costs around $72. For many folks, this cost ratio is way out of whack. In fact, the average American under the age of 50 now watches more content per month on streaming services like Netflix than on cable TV. And that means that on a usage basis, Netflix is an absolute bargain.

On the other side of the argument, there are two major reasons to be worried about Netflix going forward…

Competition is fierce… and getting fiercer. In a recent letter to investors, Netflix management said…

We compete for entertainment time with linear TV, YouTube, video gaming, web browsing, social media, DVD and [pay-per view], and more… As Internet entertainment grows, more companies see the large opportunity.

In other words, Netflix is seeing increased competition coming from all sides.

It’s competing against traditional media companies like Disney and Time Warner’s HBO, which are starting to focus more on their own streaming services. Disney’s shift is particularly worrisome. Among Netflix’s most-watched content were Disney’s animation and superhero offerings (Marvel and Lucasfilm). Disney recently announced that starting next year, it’s pulling its new content from Netflix in favor of its own streaming service.

Netflix also faces competition from global tech behemoths Apple (AAPL), Google parent company Alphabet (GOOGL), and Amazon (AMZN). These three should terrify shareholders.

Apple has Apple TV… it’s starting to invest in its own content… and its $240 billion pile of cash is larger than the GDP of most countries. Google owns YouTube, the No. 2 streaming site behind Netflix, which is also investing in premium content. And Amazon’s Prime Video is a rapidly growing No. 3. CEO Jeff Bezos – who seems to be taking over every other industry – has recently declared video as a likely “fourth pillar” focus for the company.

Not only do these three companies want to provide you with content, but they want to control the “pipes” for how you consume that content. They all have operating systems – Apple’s iOS, Google’s Android, and Amazon’s Alexa – whose goal it is to be the operating system for your life. That means on your phone, in your home, and pretty much everywhere you can imagine… And that includes making their own offerings the default way for how you watch shows and movies.

The second – and even bigger – concern is that Netflix’s current business model is totally unsustainable…

Netflix has a dirty little secret: It’s burning through cash like no other media company on the planet.

This is by far Netflix’s biggest problem, and one that it will eventually need to solve. It makes the company’s business unsustainable. The worst part is, the bigger Netflix grows, the more money it loses.

You won’t see this on its income statement. The company has changed its accounting methodology to make sure of it. According to the income statement, Netflix is profitable. It generated more than $500 million in net income in 2017, and analysts expect that to double this year.

But as any vigilant investor knows, net income doesn’t always tell the true story about a company’s actual earning power. To get that, we must look at a company’s free cash flow (“FCF”). We call FCF “the number that doesn’t lie.”

Free cash flow is what’s left after a company pays for all cash expenses and capital investments. That makes it a great measure of a company’s true earnings power. It can use that FCF to reward shareholders through dividends and buybacks, or to invest back into the company for incremental growth.

It’s worth noting that sometimes the profits reported on a company’s income statement understate its earnings power. That’s often the case with subscription businesses such as Stansberry Research or a software-as-a-service (“SaaS”) provider. These businesses generally receive cash up front – sometimes for long-term service relationships – and record revenues and profits over time.

But in the case of Netflix, it’s the opposite… The company’s income statement vastly overstatesits earnings power.

The main reason for this is a delay in when Netflix recognizes spending for media content. Consider the following: On its investor relations website, Netflix writes…

In 2018, we expect to spend close to $8 billion on a [profit and loss] basis on content for our members.

Now, $8 billion is a ton of money to spend on content – more than any other company spends besides Disney. But the problem for investors is that the amount Netflix will actually spend this year – on a cash basis – is more than $12 billion.

Rather than recognizing all of this spending today, Netflix delays the profit hit. Management argues that the useful life of this content is far longer than just a year, so the company should spread those costs over time. But this makes Netflix’s financials aggressive… and misleading.

The following chart shows this powerful trend at work…

Over the past five years, Netflix has reported a total of $1.2 billion in net income. In reality, its true earnings power is much worse… Over the same period, Netflix hemorrhaged free cash flow every year, for a total of negative $4.8 billion… or a difference of more than $6 billion between the profits Netflix reported and the losses it actually generated.

But it gets even worse… Netflix has already forecast FCF losses of $3 billion to $4 billion in 2018 and 2019 each year. This amount of negative FCF is shockingly bad for a company expected to generate less than $16 billion in revenues in 2018.

In other words, for every dollar of revenue it generates this year, Netflix expects to losearound $0.25. How’s that for a viable long-term business model?

Netflix can’t continue like this forever. At some point, the company must make money. And yet, a recent letter to investors suggests that won’t happen anytime soon (emphasis added)…

With continued “success,” we will invest more in originals, which would continue to weigh on FCF, even after we achieve material global profitability. As a result, we anticipate being free cash flow negative for many years.

Investing in the stock today means you’re signing up for billions in losses per year for the foreseeable future.

Now, I’m not saying you should sell shares of Netflix short…

As I explained earlier, the company is an industry disruptor, is growing rapidly, and has tremendous pricing power.

Still, FCF would have to dramatically change for the better before I’d tell any investor to buy shares. That could happen… Netflix could grow its user base faster than its content spending. But over the past eight years, the company has grown its subscriber base by 29% per year while growing the cost of its content by 54% per year.

Or Netflix could take advantage of its pricing power and raise the cost of a subscription on a happy user base that would be likely to oblige.

But until then, investors should stay far, far away from Netflix. It’s growing too fast and its customers love it too much to sell short today… But its market is too competitive, and its cash flows are too negative to go long.

Netflix is a fascinating company to analyze…

And over the past nine years, it has been a great example of a stock that can soar during a bull market starved for growth companies.

But it also represents a great lesson on the difference between accounting net income and true free cash flow. Ultimately, you can’t ignore FCF.

When the bear market finally arrives, Netflix could become the poster child of what not to own. By then, no one will care that Netflix added 1 million subscribers if it burned through billions of dollars to get them.

In the meantime, I recommend keeping close tabs on Netflix’s quarterly numbers, because its share price could tell us a lot about the health of the overall market.



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Why artificial intelligence is the future of investing




From Richard Smith, Founder, TradeStops:

Artificial intelligence — and “deep learning,” a specific form of artificial intelligence — is changing the face of investing.

This is not something that will happen in the future. It is already happening. The changes are widespread and they will only intensify in the coming years.

This could be seen as good or bad news, depending on how you look at it. Artificial intelligence, or AI, is a powerful form of technology that is brand new to most people. That makes it frightening as well as exciting.

There is also a lot of hype surrounding AI, including overblown predictions of what artificial intelligence will do (and what science will be able to achieve). Sometimes it’s hard to separate the reality from the fantasy — and some have a vested interest in drumming up fear and worry.

The good news is that AI, through a technique known as “deep learning,” will be an incredible resource for individual investors. The widespread availability of low-cost computing power and increasingly powerful software programs means that the benefits of AI will ultimately flow to Main Street, and not just Wall Street or Silicon Valley.

And yet, when you hear about artificial intelligence in the news these days, it is often attached to a big prediction or a slightly ominous sounding breakthrough. For example, a London-based artificial intelligence company called DeepMind — which is owned by Alphabet, the parent company of Google — recently announced an “intuition” breakthrough in one of its game-playing AI programs.

AlphaZero, a descendant of DeepMind’s AlphaGo, is an AI machine that shows human-like creativity in games like chess and shogi (Japanese chess).

Human grandmasters, like the world-famous Garry Kasparov, have confirmed the surprising degree of “creativity” in AlphaZero’s style of play, with a willingness to take risks and make bold, unconventional moves that feel more human than machine-like.

The gameplay, however, is just a means of testing capabilities and generating publicity. The goal of DeepMind is not to design an ever-more-impressive roster of game-playing machines, but to tackle tricky and lucrative real-world problems, like the development of pharmaceutical drugs.

In the pharma world, for example, predicting the three-dimensional structure of proteins — also known as “protein folding” — is an important area where DeepMind hopes to apply deep learning techniques.

Protein structures are at the core of many life-saving drugs. If you count up all the seconds that have ticked by since the universe began, there are more potential protein-folding combinations than that very large number.

That makes the design of new protein-based drugs very challenging, and an area where an AI program — like a pharmaceutical version of AlphaZero — could accelerate the process by orders of magnitude.

It’s important, though, to clarify what is not going to happen.

AlphaZero is not close to “awareness” or “consciousness” or anything resembling human brain activity. And in fact, this particular area of AI is widely hyped and overblown.

Broadly speaking there are two types of artificial intelligence: narrow and general.

“Narrow AI” is focused on a very specific task. It is far more like a software program than anything else. The much more ambitious “general AI” is the notion of computer code achieving something like human consciousness.

Narrow AI is already here. You see it in all kinds of places, and likely make use of it multiple times without realizing it on any given day.

Narrow AI does things like auto-complete the text you type into your smartphone, translate a foreign language web page, or give suggestions for restaurants or coffee shops based on your GPS location. It does very specific things, typically by parsing large amounts of data in real-time.

General AI only exists in Hollywood movies. It is the computer that is supposedly smarter than a million humans, or the army of terminator droids trying to wipe out humanity.

A handful of experts think General AI could arrive in a decade. But those are extreme outliers. A far higher number of experts think General AI — a sort of computer-based consciousness, or a program smart enough to have awareness — could take 50 to 100 years, or in fact may never arrive at all.

In spite of the fact that smart speakers like Alexa can mimic a conversation, conscious AI is nowhere close to being achieved, and may not even be possible.

The current AI techniques being deployed aren’t in the same ballpark as General AI. They aren’t even the same sport. We may actually be closer to reaching Mars, or even colonizing Mars, than we are to any kind of substantial General AI breakthrough. That’s how big the Narrow vs. General gap is.

So, even though DeepMind as a company talks about its AI having “intuition,” we shouldn’t confuse that with any kind of march toward human consciousness. It is possible for an AI program to show what appears to be creativity, and to be useful in all kinds of powerful ways, without being conscious at all.

This is what “deep learning,” a specific type of artificial intelligence, is all about — helping human researchers (and investors) become more powerful in various ways.

Deep learning relies on “neural networks.” Because of this, the claim is that deep learning, as a technique, mimics the structure of the human brain. This is far from true.

It sounds sexy to suggest that AI mimics the human brain, because it implies that, if you go along this path far enough, you get consciousness.

The reality is far more basic, but still fascinating. It is possible to exploit the power of “neural networks” without trying to copy the human brain at all, except in a super-abstract way, and that is what deep learning does.

The “neural” part means storing information as a network of nodes, with recognition capabilities — the program’s version of awareness — distributed across multiple nodes, rather than residing in any one place like a text file.

To understand how deep learning works, imagine you come from a far-off land where there are no housecats. You have never seen a housecat before, or a cat of any kind.

Traveling to the United States, your host wants to teach you what a cat is. But instead of describing a housecat, or introducing you to a live one, they show you pictures of housecats.

After a while, in order to test your knowledge, your host starts showing you thousands of pictures, some of them with housecats and many of them without.

You make guesses as to which picture contains a housecat and which doesn’t. With each guess you get feedback — “correct” or “incorrect” — and over time your guesses improve.

Eventually, sticking at this for long enough, you have a pretty good sense of what a housecat looks like, thanks to huge volumes of trial and error.

Deep learning as an AI technique essentially does the same thing.

A computer program is taught to identify a pattern — like, say, the shape of a cat in a picture.

The program tries to “guess” at the pattern, over and over, getting feedback each time. After hundreds of thousands or even millions of guesses, the program has a pretty good sense of what a cat looks like.

This methodology requires huge volumes of data for the program to train itself. That is why giant tech companies like Google, Amazon and Alibaba have such an edge in these areas — nobody else has access to oceans of data like they do.

But again, this brute-force means of recognizing patterns within patterns is nowhere near human consciousness. It is a million miles away from it.

And yet this deep learning technique is extremely valuable, because AI-powered software can:

  • Detect data patterns that are very subtle and complex
  • Sift through huge mountains of data (find needles in a haystack)
  • Get better at pattern-spotting through testing and feedback
  • Identify useful or valuable patterns instantly and in real-time

And that, in turn, explains why deep learning is the future of investing.

In the hands of regular investors, artificial intelligence tools can scan vast quantities of data to identify useful and important patterns via deep learning techniques. Investors can then use those patterns to make better investment choices.

A key point here is that, from an investing perspective at least, the human being does not get replaced. Human behavior still plays a key role. Human decision-making and human emotion are still big factors.

But software with AI-like capabilities, enabled by powerful deep learning algorithms, can serve as an investor’s eyes and ears.

The software can scan thousands of stocks in real time — something a human can’t do. The software can also look for subtle patterns in the investor’s own behavior and investment record, and make possible suggestions for improvement. These capabilities, and more, make the investor more capable and powerful — and potentially more successful.

Those ideas just scratch the surface. The point is that, while artificial intelligence is a big, complex topic that is both exciting and a little frightening, the dawn of AI — via deep learning — is opening up a world of new possibilities for individual investors.

And this AI investment revolution, so to speak, is truly democratic because the barriers to entry are low and falling. With each passing month, if not each passing day, chips get cheaper and investment software gets more powerful.

That means you won’t have to be a Silicon Valley tech titan or a rich hedge fund mogul to utilize AI-powered software. We can be certain about this because our mission and vision, as a software company, is to empower individual investors.

It’s our bread and butter, and we can’t wait to show you what’s in store for 2019.


Crux note: More than 25,000 investors are using TradeStops to help manage risk in their portfolios. Try it for yourself today with a one-month free trial.  

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Cramer’s charts signal a potential bottom for the major averages




The stock market’s recent swings might not be as bad as investors think, especially when stacked against their historical performance, technical expert Rob Moreno told CNBC’s Jim Cramer on Tuesday.

After consulting the charts of the major averages, Moreno, the publisher of and Cramer’s colleague at, concluded that stocks are in a consolidation phase, trying to digest the gains from a multi-year bull market.

And “the charts, as interpreted by Rob Moreno, suggest that the averages are trying to bottom here in preparation for a nice rebound,” Cramer, host of “Mad Money,” told investors.

Cramer pointed out that since the end of the financial crisis, the averages have climbed steadily higher. The Dow Jones Industrial Average, for one, bottomed at roughly 6,500 in March 2009 and has since traded above 24,000.

But this consolidation period is atypical, Cramer admitted. Normally, times like these “tend to be sedate [and] fairly limited” when it comes to trading; this one has been much more volatile, or prone to big swings, he said.

According to Moreno, “the best way to navigate your way through it is by taking a wider view of the landscape, because that’s the only way you can get enough … perspective that you won’t panic,” Cramer said. “Sure, the decline’s been brutal, but he says we’ve been through previous consolidation periods that were even more volatile and they didn’t derail the bull.”

First, Cramer turned to Moreno’s logarithmic chart of the Nasdaq Composite index. Technicians use logarithmic charts, which measure percentage moves rather than basis points, to compare market action over long periods of time.

“Moreno points out that in 2010, 2011 [and] 2015, there were periods of consolidation that had even wider ranges than the one we’re experiencing now,” Cramer said. “Even though the Nasdaq’s lost a lot of points here, on a percentage basis, the 16 percent decline [from its October highs to its November lows] is smaller than 2010, 2011 or 2015, and each of those times, the market ultimately rebounded phenomenally.”

Moreno also noted the major averages’ floors of support and ceilings of resistance, key levels that technicians watch to know when a given index or stock might change course.

The weekly chart of the S&P 500 showed a ceiling of resistance at 2,800 and a floor of support between 2,550 and 2,600, a range in which that index has been stuck all year. The Dow’s weekly chart had a ceiling at 26,000 and a floor between 23,500 and 24,000, not far below where the Dow was trading on Tuesday.

“In Moreno’s eyes, it looks like the Dow and the S&P are both trying to hammer out a bottom,” Cramer said. As for the Nasdaq, which is trading in the middle of its range, “Moreno wants to see what’s known as a hammer candle, where … the Nasdaq rallies and closes on Friday near its highs for the week. That would send a signal that the bottom will hold and perhaps we could rebound back to the high end of the range.”

The best part — at least for investors who believe Moreno’s call that this isn’t a bear market, but a consolidation phase — was that even if the averages fall below their floors of support, this is likely still a buying opportunity, Cramer said.

“If you have conviction, you might want to do some buying, seeing as the major averages are all pretty close to their floors of support, and even if these floors are violated, Moreno doesn’t think we’ll have a whole lot more downside,” he said.

Moreno added that buyers should watch for what’s called an eveningstar candle pattern to make their move: in short, it’s a three-day phenomenon when the market rallies for a day, maintains a tight trading range the next day, and then sees an unusually negative trading session.

All in all, “Moreno thinks that the situation might not be as bad as it seems,” Cramer said. “This all sounds a little too sanguine for me given everything that’s going on, but you know what? I think it’s heartening to put these declines in a more constructive perspective.”

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FAANG stocks turn red: What to buy when the market goes nuts




From Jeff Clark, Editor, Delta Report

According to the efficient market hypothesis, there’s nothing insane going on in the stock market. Stock prices reflect all of the currently available information and investors’ analysis of that information.


In the long term, I’ll agree that markets are efficient. Investors are rational. And stock prices generally end up where they are logically supposed to.

In the short term, though, the market is nuts.

In the short term, stock prices react to emotion, not logic. Fear and greed are more powerful in the short term than a thoughtful analysis of balance sheets and income statements. That’s why crazy things sometimes happen in the stock market.

Back in 2000, for example, any rational person could see the dot-com bubble inflating. Stocks with no earnings, no revenue, and no hope of either were pressing higher nearly every day. Meanwhile, traditional businesses – with long track records of earnings growth, stable dividends, and long-term business prospects – couldn’t catch a bid.

In 2000, I did not own a single dot-com stock. Instead, my largest holding was Cooper Tire & Rubber (CTB). At the time, CTB was an 87-year-old company. When I started buying the stock in early 2000 at $9 per share, CTB traded at six times earnings and paid a better than 5% dividend.

CTB promptly dropped to $6 per share.

The stock lost 33% of its value in early 2000, at a time when the average dot-com stock was racing to the moon.

As you might imagine, the clients at my brokerage firm were frustrated. Their friends and neighbors were bragging about the piles of money they were making in and Meanwhile, my clients were stuck in a dusty, old, tire and rubber stock that just seemed to fall every… single… day.

All I could do to console my customers was to tell them that sometimes the markets do screwy things. Sometimes, logic takes a vacation. Stocks that shouldn’t go up, do. Stocks that should rally, don’t.

And it is during those times that investors who have the ability to curtail their emotions also have the ability to make outsized gains. But, you can only make those gains by going against the emotions of fear and greed… and betting on logic instead.

I lost several clients in early 2000. I refused to buy the dot-com stocks. I stuck with buying old, time-tested companies trading at steep discounts to their historic valuations.

By early 2002, most of the dot-com stocks had crashed and burned. The customers who stuck with me were cashing out their Cooper Tire & Rubber trade for a 150% gain.

Here’s my point…

While the focus in my Delta Report trading service is on shorter-term trading – where we attempt to get into a position one day and get out of it a few days later – there are times in the market where it can be far more profitable to take a slightly longer-term view.

Investors’ short-term emotions have decoupled from longer-term logic. So, asset prices have, for lack of a more sophisticated term, gotten out of whack.

It is during these times that it can be HUGELY profitable to take a BIG SWING.

Find a stock that is grossly undervalued by almost every fundamental metric. Find a stock that just can’t seem to get off the mat. Find a stock that nobody likes… a stock that if you mention it at a cocktail party, you end up drinking alone.

Then, buy that stock and hold it for a few months.

You won’t be disappointed.

Best regards and good trading,

Jeff Clark

P.S. Like I mentioned above, the focus in my Delta Report trading service is on shorter-term trading. It’s all about how to maximize your profits while still reducing risk.

The Wall Street players lose a lot of money because they’re always looking for that big swing moment. Though those moments do exist, they aren’t common. My risk-reducing methods have proven that you can make a lot of money while not betting the farm on every trade.

You can read more about my proven trading philosophy right here.

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