I hear you Reed Hastings, I'm long Netflix

Reed Hastings

I am long Netflix, and have been so for quite some time. My Silicon Valley 2.0 portfolio is currently outperforming the S&P by some 27 percent annually. Netflix is one of my top five holdings.

Due to the popularity of its video subscription service, Netflix stock has skyrocketed. The stock has more than tripled in the past year - up 245 percent, to be exact. The company's stock is the best performing stock on the tech-heavy Nasdaq exchange over the past one- and three-year periods among companies with a market capitalization above $5 billion.

This dizzying upward spiral has led to a debate among investors and pundits about whether or not Netflix stock is overvalued. The highlight of this debate was a recent open letter in Seeking Alpha by Netflix CEO Reed Hastings debunking a lengthy Seeking Alpha essay by noted investor Whitney Tilson, who called for investors to short the stock.

In the conclusion to his detailed response, Hastings said, "I have to agree with my friend Whitney that there are many risks ahead for Netflix, that our valuation is substantial, and that it is possible that one could make money shorting Netflix today. But shorting a market leading firm as it is driving a huge new market is" not advisable.

I agree with Hastings' observation. Netflix is a growth stock, I believe. Tilson begs to differ. He thinks Netflix's best days are behind it. In so many words, Tilson proposes shorting Netflix stock because the company will be overwhelmed by larger competitors, namely Apple, Google and Amazon. His litany of prohibitive margin pitfalls that await Netflix in its quest for premium content form the crux of his reasoning for shorting the stock.

The new streaming video paradigm, said Tilson, "isn't the beginning of an exciting, highly-profitable new world for Netflix, but rather the beginning of the end of its incredible run. In particular," Tilson proclaims, "we think margins will be severely compressed and growth will slow over the next year."

I differ with Tilson on two key points. First, and foremost, Tilson readily acknowledges that he has lost a considerable amount of money shorting Netflix. For me, that, in and of itself, is a deal breaker. He's suggesting to investors that they jump aboard his sinking ship. At the end of the day, Tilson will end up shipwrecked, not Netflix. Secondly, Tilson is a self-proclaimed value investor. He has, however, denigrated the concept of value investing by loudly proclaiming the dubious merits of shorting a pioneering, market leading growth company based largely on a fear of the unchartered streaming video waters.

Investing in growth companies is admittedly a risky business. Shorting a growth company as substantial as Netflix is even riskier. I wouldn't advise it. Tilson, I believe, is blinded by his prejudice for value investing. He engages in a mind-numbing, bean counting assessment of potential margin problems that Netflix may encounter because he does not believe that a company that small can compete with Apple, Google and Amazon.

In addition to Netflix, Riverbed and VeriFone are among the top five holdings in my Silicon Valley 2.0 fund that has consistently outperformed the S&P by well over 20 percent for over two years. Riverbed and VeriFone are small Silicon Valley companies successfully competing against industry titans. Riverbed's chief competition is Cisco. VeriFone is up against Visa, MasterCard, Verizon and AT&T, to name a few. In the long run, I believe, Riverbed and VeriFone will prove to be pioneers, as will Netflix.

Part of what Tilson conveniently overlooks is that Apple and Amazon have successfully engaged in David and Goliath struggles of their own. Netflix, too, will succeed for two main reasons. Reed Hastings, Fortune magazine's Businessperson of the Year, will provide the necessary leadership. Secondly, Netflix is focused on streaming video and is a key player in the nascent Web television market.  Apple, Google and Amazon have far-flung empires that distract their attention to streaming video.