It seems I have an increasing number of friends who have been telling me about how they really like their Netflix subscriptions so I was interested in a discussion currently going on in the ManifestInvesting forums about investing in their stock.

This company is a good example of one where the ROE or Return on Equity has made a significant jump lately. Improving ROE can be an indication that management is making better use of your investment (your equity) in the company to produce earnings. But you need to use the information it is providing cautiously. As is happening here, there are limitations to what it is telling you.

I took a look at the Netflix annual report and found some interesting information on their balance sheet. During 2009, they made significant changes in their capitalization structure with a new bond issue and new lease commitments. Prior to 2008, they had no long term debt, but as of 2009 more than half of their capitalization is coming from long term debt commitments.

The reason their Return on Equity has gone way up is because their equity has gone way down. It has decreased from $347,155 in 2008 to $199,143 in 2009.

Financing your operations with increased debt rather than earnings brings along increased costs and vulnerabilities to your business.

This new burden for them is certainly is something to consider if you are trying to decide whether their earnings per share growth will be as exuberant and as consistent as it has been in the past.

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Laurie Frederiksen
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