David Sterman

There is one huge risk when it comes to owning shares of high-growth companies. No one really knows how far or how close the company is to market saturation, so investors (and Wall Street analysts) are left to trust the company as it keeps issuing bullish guidance. When the era of strong growth finally comes to an end, few will have seen it coming.

That's the challenge that investors face with Netflix (Nasdaq: NFLX), a former highflier that may soon possess a fairly mature business model.

I laid out the looming challenges for Netflix roughly two months ago, and suggested either taking profits or shorting the stock outright. This week's plunge does not imply that the selling is done, and I still see this stock moving below $70 -- or possibly even lower in coming quarters.

Taking it on faith
In his review of first-quarter results, Netflix's CEO Reed Hastings noted that the company's growth in the current quarter will slow to a crawl, as rising numbers of streaming customers will be mostly offset by a commensurate dip in DVD-by-mail customers. The company is now pulling out all the stops to make this a streaming-focused business, taking a huge risk as the streaming business margins (roughly 15%) are a fraction of the DVD-by-mail business (40%-plus). The growth in the lower-margin business means that blended gross margins, which had been 29% in December 2011, fell more than 300 basis points sequentially. That's a huge red flag.

David Sterman

David Sterman has worked as an investment analyst for nearly two decades. He is currently an analyst for StreetAuthority.com

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