Barron’s ($) highlighted the beat up newspaper stocks in this weekend’s edition and made a compelling case for owning the stocks based on their valuation. However, I disagree with their reasoning and with their conclusion. I think you should line your birdcage with the newspaper stocks, not your portfolio.
The magazine wrote "Newspapers undoubtedly face problems, but the stocks look pretty attractive, with industry leaders Gannett, Tribune and Knight Ridder trading at around 15 times projected 2005 profits. Valuations have gotten low enough that it’s possible that Tribune or Knight Ridder could be targeted for leveraged buyouts from cash-rich private-equity firms. Moreover, if the stocks merely get back to their 52-week highs, they could rise 15% to 50%."
I couldn’t agree less with their reasoning that the stocks are cheap. One of the easiest ways to fall into the value trap is by buying "cheap" stocks that are in a secular decline. Looking at a broad swath of valuation measures indicates to me that the companies are trading at a median valuation, at best, and are still expensive, at worst. For companies that have been performing poorly and have declining prospects, the valuations aren’t nearly compelling enough to warrant a buy.
First, the stocks look fairly attractive on a trailing P/E basis. However, as I’ll point out, the forward earnings estimates are being slashed. Trailing earnings for these stocks do not mean much.
One worrisome valuation measure is price to sales, which still seems very high to me. The group currently trades at 2.2x revenues which is still slightly above the historical median valuation of the stocks. I have used the Publishing group from Baseline as a guide to overall valuation. The Publishing group is composed of DJ, GCI, KRI, MHP, MDP, NYT, and TRB.
Chart Courtesy Baseline
Relative to the S&P 500, which in itself isn’t that cheap, the stocks look fairly valued on a trailing P/E basis (again, probably not a good measure) and look REALLY expensive on a P/S basis.
Chart Courtesy Baseline
To Barron’s credit, they do point out that the dividend yield for the stocks is relatively low. The dividend yield for the group stands at a paltry average of 1.6%. That’s even lower than the S&P 500’s yield. For companies in secular decline that only have cash flow to throw off, this low dividend policy seems wrong. I’m guessing that management either sees the secular decline coming or understands the cyclical nature of their business and isn’t interested in paying out too much cash.
The real problem in making a case that newspaper stocks are cheap is the fact that earnings estimates are in a free fall. The chart below shows the estimates for the group for the past six months. While the earnings are still expected to grow by 3%, the estimates have been steadily reduced from $17.47 to $16.91 per share. I wouldn’t be surprised to see year over year growth be negative once we get into the second quarter earnings season. Without confidence in the stability of forward earnings and cash flow, it’s very difficult to make a valuation argument for owning the stocks.
I’ll even use one of Barron’s charts to make my case that these stocks are very unattractive. This is from the Monday June 13 edition of Barron’s –
"Newspapers have steadily lost advertising market share in the past 15 years to cable TV and, most recently, the Internet. The industry’s challenge is to stabilize its share and push through modest price increases to boost earnings."
| Advertising Market Share | ||||
| Category | 1990 | 1995 | 2000 | 2005* |
| Newspapers | 36.2% | 32.9% | 28.4% | 26.7% |
| Broadcast TV | 30.4 | 29.9 | 26.3 | 24.2 |
| Cable TV | 3.0 | 5.0 | 8.0 | 10.2 |
| Radio | 9.9 | 10.5 | 11.6 | 10.9 |
| Internet | 0 | 0.1 | 4.7 | 6.1 |
| Other** | 20.5 | 21.7 | 21.1 | 22.9 |
You’ll notice that the advertising share for Newspapers has steadily fallen for the past decade, while Internet advertising is climbing steadily. I think this trend is still in the early stages and shows no signs of slowing. The majority of Internet users are just now adopting broadband connections and with it, will be able to view more video which is even more conducive to advertising. In addition, job, home and car classifieds, which are the most profitable ads for newspaper companies, are all steadily moving to the Internet.
Ironically, the best case I can make for owning the stocks is that these trends are apparent to most investors and the short interest has risen steadily for most companies in the group. That means any news that’s not as bad as expected could cause a short squeeze. In addition, the announcement of a leveraged buyout could also buoy the stocks. However, a short squeeze in a stock that is in a secular decline presents an opportunity to trade the stock, not invest in it for the long term (see GM).
Charts courtesy Bloomberg
When would I consider investing in newspaper stocks? On all the valuation charts, you’ll notice the dip the stocks took in 1998, which was partially due to concerns over Internet advertising. I think once the stock revisit these levels on a P/S and P/B basis, you might be able to make a case for them being cheap. However, I would also like to see the advertising market share numbers stabilize and the earnings estimates reach a trough. I have very little confidence in estimating free cash flow and earnings for an industry that is in such steady secular decline. And without stability in these measures it’s virtually impossible to make the argument that the newspaper stocks are cheap.