Netflix: Why it's worth the risk

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Chris Umiastowski is the growth investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.

Last week I highlighted the biggest loser in my Strategy Lab portfolio and explained why I feel Apple Inc. is still a solid stock to own despite its recent collapse from almost $700 (U.S.) to around $450.

Today, let's look at the opposite end of the spectrum. The biggest winner in my model growth portfolio is up almost 200 per cent. It's a stock that has succeeded in reinventing its business over the past five years. It is (drumroll, please) Netflix Inc.

I included Netflix in my Strategy Lab portfolio because it occupies a dominant position in an area that is bound to grow in the years ahead. It is a major player in "over the top" (OTT) video, meaning video that comes in over top of your broadband Internet connection. I firmly believe that OTT video will displace the traditional cable model over the next decade. My kids are growing up with no clue that such a thing as cable TV even exists.

Netflix began life by renting DVDs through the mail. Subscribers in the U.S. market loved the ability to pick movies online and have DVDs arrive in their mailbox a few days later with a return envelope included. The success of Netflix in the DVD market played a big factor in the bankruptcy of Blockbuster, a major bricks-and-mortar competitor.

Reed Hastings, the man who founded Netflix in 1998, is still CEO today. He's a long-term thinker. Under his leadership, Netflix started investing in streaming media technology well before the service launched in 2007. I was skeptical. I didn't think the Internet was reliable enough for high-quality movies on big TV screens back then. But reports from friends in the United States convinced me I was wrong.

Fast forward five years and Netflix is the dominant force in OTT video. Its streaming service works beautifully on PCs, Macs, the iPad and iPhone, Microsoft Xbox, Sony PlayStation and a wide variety of other players.

If you accept the idea that TV is moving online then it becomes a race to acquire the most content. Netflix knows it has plenty of holes in its video library. It's signing new deals and even producing its own original series to make Netflix content more exclusive. Doing this is expensive, and means the company won't be highly profitable over the next few years. That's fine by me.

When I added the stock to my Strategy Lab portfolio, it seemed absurdly cheap at about $58 per share, giving the firm a market capitalization of $3.2-billion. For a company with nearly 30 million streaming customers (and tons of growth to come), the per-subscriber value of about $100 seemed too low to last. And it was. The stock now trades at about $175 a share. It rallied sharply last week after posting a surprise profit of $8-million when Wall Street expected a loss. The company added nearly 4 million new streaming subscribers, bringing the total base of customers to 33 million.

I'm not selling the stock and I'm not counting my (virtual) profits either. I'm in this for the long term. I expect the stock will remain highly volatile. I am not surprised when I see headlines forecasting the stock to come crashing down. If we wait long enough, it is guaranteed to have a crash. I just don't think anyone can really predict when this happens, so I don't play that game.

Netflix is a risky stock. Most experts would tell you my entire Strategy Lab portfolio is made up of risky stocks. Individually, this is true. But when you diversify across a wide variety of technology leaders the risk decreases. And when you take a very long term horizon on your investments the concept of volatility is far less relevant, with the notable exception that it gives you a chance to buy more stock when prices drop.

So, yes, Apple is my biggest loser so far. But I don't think of it that way, just as you won't catch me giving anyone high fives over my model portfolio's first triple bagger.

Investing is a marathon, not a sprint.