Small-Cap Spotlight: Netflix Not Worth Watching

But any investor who jumped onto the Blockbuster bandwagon was greeted by a nasty surprise in May 2007, as the company missed first-quarter estimates by 11 cents. As it turns out, the online business remains a difficult space to make money in. The business wasn't generating the kind of margins that investors and analysts expected because the growth in Total Access forced the company to carry more inventory and spend more on advertising, while keeping prices down to compete with Netflix.

Anyone looking to invest in Netflix should be aware of this story because it illustrates the difficulties of the current DVD rental business, as well as the link between stock performance and investor/analyst sentiment. When everyone thinks that things are a lot better -- that's when investors should be most wary about this business.

As Frank outlined, Netflix's recent history has a lot in common with the Blockbuster story. Shares of Netflix were stuck in a brutal downtrend, falling well under $20 this summer as management lowered guidance and announced a $1 price reduction on its most popular plans.

I don't think it's a coincidence that Netflix's current 52-week low occurred on July 24, the same day analysts were issuing downgrades and generally bemoaning the company's terrible outlook. A report that day from investment bank Jefferies summed things up with the title, "No Relief in Sight; Maintaining Hold and $16 Price Target."