Netflix shares slump as earnings rally fades

Ryan Vlastelica and Angela Moon

By Ryan Vlastelica and Angela Moon

NEW YORK (Reuters) - Investors turned on Netflix Inc on Tuesday, reversing early gains in a flurry of selling that bore the hallmark of momentum traders getting out of the high-flying stock.

After rising nearly 10 percent at the open, Netflix, the year's best performer in the S&P 500 index, was met with immediate selling that picked up once shares moved into negative territory on the day. Volume spiked as shares fell, a sign of hot money leaving the stock.

"Being such a big momentum trader-oriented name, I think people were very quick to capitalize on the pullback from the morning's highs," said Michael James, managing director of equity trading at Wedbush Securities in Los Angeles.

Netflix shares were down 8 percent to $326.15 (200.90 pounds) in afternoon trading after rising as high as $389.16. More than 22 million shares had changed hands, several times the stock's 50-day average volume and the highest since late January.

Coming into the day, Netflix shares were up 282 percent on the year. The company surprised investors by reporting stronger-than-expected quarterly profits and subscriber growth on Monday, sending its shares soaring.

"This is a horrible one-day reversal, taking out yesterday's action. We saw both higher highs and lower lows today, which is proof the stock is exhausted," said Frank Gretz, market analyst and technician for Shields & Co in New York.

"This isn't a market killer but it will be more concerning if it follows through on this decline tomorrow."

The stock's gains this year have led many analysts to say the stock is vastly overvalued, with a price-to-earnings ratio of 113 that dwarfs the 16.44 ratio of its industry peers. Last week the stock jumped 11 percent ahead of the earnings.

While more than a dozen brokerages raised their price targets on the stock following the strong results, many of the targets remain below Netflix's current share price, a sign that even accelerated growth may not be enough to justify the company's nearly $21 billion market cap.

In a letter to shareholders released in conjunction with the results late Monday, Chief Executive Reed Hastings and Chief Financial Officer David Wells downplayed some of the recent share gains, calling them reminiscent of similar surges in 2003, which preceded a sharp pullback. At that time, "we had solid results compounded by momentum-investor-fuelled euphoria," they wrote.

Short interest in the stock fell about 15 percent from mid-September to 6,956,792 shares as of September 30, according to the latest data from Nasdaq. It was the lowest level since the end of July, suggesting that despite the stock's stunning gains, fewer investors are betting on the downside.

Tuesday's selling in Netflix spread to other big winners this year, including Tesla Motors Inc,, and All were lower on the day.

"Once (Netflix) started weakening, you started seeing other momentum names with high betas that have been big winners this year and recently all started coming under significant pressure," said James, referring to stocks that are generally more volatile than the rest of the market.

In the options market, overall trading volume in Netflix was more than four times greater than the recent daily average, according to options analytics firm Trade Alert.

(Additional reporting by Doris Frankel and Caroline Valetkevitch; Editing by John Wallace)