There are three lessons embedded in this chart.The emphasized sentence illustrates my point. ALL share prices on the secondary equity markets inherently assume "everlasting growth." That is because free cash flow models using net present valuation techniques start with today's free cash flow, assume annual growth over 3-5 years at a one rate, and then assume a terminal value which is based on lower, but now perpetual, annual growth rate into the future.
The first is that exponential (compound) growth does not last forever.
The second is that when (not if) the party ends, the usual path is straight down, while the climb up was (by comparison) rather sedate.
And the third is that you can make it much worse by doing stupid things.
Netflix was a prime example of all three in action . The firm sold the market on the premise of "everlasting growth." That premise forgot the fact that they had created the "brand" on the back of a skeptical industry that underpriced their services - and that these "teaser rates" for content access would end. There was no way for Netflix to win on this, as they'd either fail outright or the content cost ramp would nail them if they were "successful." These risks were disclosed and nobody paid attention to them.
What Karl is really complaining about with NFLX is the slope of the increase stock price, which is based as much or more on the P/E multiple applied to the assumed level of perpetual growth as on the premise of "everlasting growth," which is common to all companies sold on the secondary equity markets.
Again, I wish Karl luck with his book. As often as I disagree with the man, he is a genuinely good guy who, like Jesse and Charles Hugh Smith among the A-list financial bloggers, should always be taken seriously ESPECIALLY when you disagree with them. People with their size audiences who continue to speak unvarnished truth are to be respected.
