Ex-colleague of Netflix's CEO: Investors who fear the stock's sky high valuation are making a big mistake

Key Points
  • "Many people have made the wrong bets" on Netflix throughout the years, says Paul Holland, who worked with Netflix CEO Reed Hastings on another venture.
  • "You just don't understand how large the market is," Holland argues. His current firm, Foundation Capital, led one of Netflix early funding rounds.
Netflix's problem is its multiple, says pro

Paul Holland, a former colleague of Netflix CEO Reed Hastings, believes the biggest mistake investors make when evaluating the streaming giant is that they "continually underestimate the market size."

"Many people have made the wrong bets" on Netflix throughout the years, Holland told CNBC's "Squawk Alley" on Wednesday. "You just don't understand how large the market is."

Holland's firm, Foundation Capital, led Netflix's Series C funding round in 1999. Holland joined Foundation Capital in 2001. He worked with Hastings on another technology venture, Pure Software, from 1992 to 1997.

Shares of Netflix opened up about 9.5 percent on Wednesday, before trimming some of those gains and closing up 5.3 percent at $364.70 per share. They were showing as much as a 15 percent rise in after-hours trading Tuesday following the company's better-than-expected third-quarter earnings.

Netflix also said Tuesday it added roughly 7 million total subscribers, both in the U.S. and internationally, for the three months ended Sept. 30. That's nearly 1.8 million more than Wall Street had expected.

Netflix stock has nearly doubled in 2018, leading some analysts to fear those lofty levels in an environment of increasing competition in the streaming industry. The price-to-earnings ratio on Netflix is nearly 130 times, according to FactSet.

"I'm very, very wary of the price," media stock specialist Larry Haverty said on CNBC alongside Holland. Content creation is like the "new gold rush," the LJH Investment Advisors managing director added, with everyone wanting a piece of the pie.

Disney's upcoming streaming service, set to launch in 2019, is already seen as a risk for Netflix.

"Disney basically owns the children's market," Haverty said. The media giant also owns the Marvel and Star Wars franchises.

However, Foundation Capital's Holland is not deterred by potential competitors: "There's such opportunity," in streaming.

Former Nickelodeon President Herb Scannell told CNBC's "Closing Bell" that Netflix's business model should be evaluated differently than that of traditional media companies. "They're all about growth" of subscribers rather than revenue, he said. "That's the way that people are measuring the success of Netflix."

Holland also "doesn't worry" about Netflix's large amount of spending on content. "They've traded effectively cash" for content, which has allowed it to "gain such a large share of the market."

Mark Mahaney, lead internet analyst at RBC Capital Markets, told CNBC in a separate interview that he believes Netflix has a trifecta of competitive advantages; "accelerating sub adds, pricing power, and expanding margins."

"The distance between them and competing offers keeps rising," he said.