Netflix operates a subscription-based DVD rental and streaming business that provided steady revenue growth. From 2008 to 2011, Netflix's revenue grew 46% annually through increasing subscriber numbers. This rapid revenue growth led to strong earnings growth and a 2600% increase in its stock price. Netflix was able to leverage its fixed costs as revenue increased, nearly tripling its operating profit over this period. The company exhibited strength prior to the market bottoming in early 2009, putting in a second low in November 2008, while its relative strength line was rising, signaling it as a potential leader.

1. Combining Fundamental and Technical Factors to Detect
Inflection Points in Innovating Companies:
Netflix
Andrew Weis
July 2015

2. Netflix operatesonasubscriptionbusinessmodel offeringDVDrentalsbymail orinternetdownloading.
The subscriptionaspecthas interestingimplicationsas acase studybecause itprovides asteadyrevenue
base that the companycan addto each quarterby signingupmore subscribers.
Acceleration
From a modestyearoveryearrevenue growth of 7% inthe March 2008 quarter (see above),revenue
growthbeganacceleratingandthiscontinuedinanearlyletterperfectfashionfor12 subsequent
quarters to a revenue growthrate of 46% inthe March 2011 quarter.
Performance
The stock appreciatedapproximately2,600% from earlyMarch 2008 to July 2015, makingNetflix one of
the top marketleadingstocksof all time.
Structural Factors
The gradual and sustainedaccelerationof Netflix’srevenueisanomalous evenforamarketleader,but
illustratesanimportantdynamicatwork.Most businesseshave ameaningful elementof fixedcosts.If a
businesscancontinue torapidlygrowitsrevenuesfaster thanitscost base,itwill become more
profitable asitgrows. Thiscreatesearningsleverage –earnings growingmarkedly fasterthanrevenues.
Accelerationinrevenue growth intensifiesthiseffect.Netflix’soperatingprofitabilitynearlytripledover
the course of the studyperiod.
TextbookExample
Netflix hadseveral quartersof veryhighdoubledigit operatingearningsgrowthinthe range of 30-95%
and twoquartersof triple digit operatingearningsgrowth,the highestbeing144%.Whena company
withsingle digittopline growthtriplesthatgrowthrate andleveragesitintotriple digitearnings
growth,the earningsmultiple awardedbythe marketcandramaticallyexpand.That’sapparentlyone
wayto get fourteenbags inthree years,evenwhenthe first yearisone of the worstbearmarketson
record.
Stock Behavior at Market Bottoms
Market correctionsare the best huntinggroundsforfuture marketleaders.One of the challengesof
growthinvesting,anddetectingmarketleaders,isthatclustersof leadingstocksare often the firstto
take off to the upside whena correctionends. The reasonisthat growthstocks typicallycorrectmore
than the majorindicesasa whole, withmarketsentimentratherthancompanyspecificissuesholding
themdown.Asa correctioniswindingup,the strongeststocksshootupas if they’re spring-loaded. A
critical faculty isremainingwatchful whenthe downwardforce of acorrectionseemstobe waning. The
Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11
Y/Y Sales Growth 7% 11% 18% 19% 21% 21% 22% 24% 25% 27% 31% 34% 46%
Y/Y Oper Inc Growth 38% 10% 101% 95% 144% 65% 23% 42% 60% 43% 43% 50% 80%

3. leadingstockswill frequently announce themselves bybreakingoutinsuccession,providingareading
on the market.
Timing isCritical
The ne plusultraof marketleaderswilloftenprovide aclue totheiridentity –the stockswill begin
exhibitingstrengthandevenbreakingout tothe upside monthsbeforeamarketcorrectionends. This
lookssuspectorinsensible inthe contextof what’stranspiring. These stocksare sostrongtheyare
attractingbuyinginterestandare not beingsoldbytheirholdersinabad market.Theirrelative strength
linessoarto the upside.
Netflix putinthe secondlegof adouble bottominlate November2008, well beforethe S&P500
bottomedinearlyMarch 2009. Netflix’srelativestrengthline bottomedinlate October2008 and began
soaringa monthlater.
Not as Easy as It Looks
Market conditions atthe time were extremelyvolatile. Netflix reported September2008 quarterly
resultsonOctober20th
. Thisreportmarkedthe secondquarterof top line acceleration,the rate of
accelerationincreasedandthe companyexhibitedamajorjumpin earningsleverage. Butthe stock
tradeddown to a newlow followingthe reportandkeptdecliningforfive days,because subscriber
growthcame inbelowexpectations.
The stock had alreadygappeddownonOctober6th
inthe marketselloff.FromSeptember25th
to the
bottominNFLX on October27th
, the stockwentfrom 32.97 to 17.94, a 45% decline. The stockclosedon

4. itslow for the day. This markedthe lowinthe stock and inrelative strength.The nextdaythe market
ralliedandthere wasan upside reversalin the stock,whichclosedonits high.
The market ralliedforsix days andthenresumeditsdecline.A keyeventoccurredonNovember20th
whenNFLXre-testedthe lowof October27th
, notchingahigherlow as the general marketputin a new
low – a divergence visible inthe relative strengthline, whichcontinuedtrending higher.
The Marker
The relative strengthline kept risingintothe Decemberquarterreporton January26, 2009 as the
general marketdeclinedduring the monthof January. Bythe time of the report the stockhad already
regainedboththe 50 dayand 200 daymovingaverages. Netflixreportedasubstantial accelerationin
subscribergrowth, anotherdropinitsper-subscriberacquisitioncosts, aslightaccelerationinrevenue
growthand anotherquarterof outsized profitgains. The nextdaythe stockgappedup onvolume of 8.6
millionshares, 750%above average volume,closingup16% to 34.82.
The gap up on huge volume signified Netflix’sleadershippotential. Notethe stocksubsequentlypulled
back to the 50 day movingaverage where itfoundsupport,butneverbroke the intradaylow of the high
volume breakaway gapof January27th
.