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The Market's Most Overvalued Stocks

The newspaper business is in terminal decline.

Matthew Coffina, 08/26/2008

Newspaper stocks have been decimated over the past year, as the Internet continues to steal readers and ad revenue from traditional print media. We think the stocks have further room to fall, as declining revenues and negative operating leverage combine to create a downward spiral for this moribund industry.

The chart below shows the performance of five newspaper stocks over the past year. Such sharp price declines (including a 52% drop for Gannett GCI an 82% dive for McClatchy MNI, and a 94% loss for rural/suburban publisher GateHouse GHS), coupled with what may be perceived as currently cheap valuation ratios, could be tempting to value-minded investors, but we say "Look out below!" 

Black, White, and Red All Over: Newspapers Drop
Newspapers have high fixed costs, like journalists' salaries for reporting. It costs the same to produce a newspaper's content whether it has a readership of 1 person or 1 million people. That gives newspapers a high degree of operating leverage: As revenues grow, operating profit grows even faster. Unfortunately, the reverse also holds true. As we expect newspaper revenues to steadily shrink in the coming years, these businesses should feel a disproportionate effect on their bottom lines.

The Internet is stealing readership and ad market share from newspapers at an accelerating pace, thanks to the Web's numerous advantages. Online news is updated as it happens. Most Internet content is provided for free. Content can be dynamic and interactive. The reader's hands aren't stained by newsprint. Advertisers prefer the Internet's younger audience and real-time feedback from click-through data. Finally, the Internet allows advertisers a low-cost way to target specific populations. We don't anticipate these trends to reverse and consider the newspaper industry unattractive as a whole.PAGEBREAK

Below, we highlight five newspaper stocks trading at significant premiums to our fair value estimates.

Gannett GCI
Economic Moat: None
FV Uncertainty: Medium
P/FV: 1.61

Gannett, publisher of USA Today, is the nation's largest newspaper company. Despite its efforts to expand into other media, newspapers represent 85% of the company's operating income. Gannett's online properties continue to show impressive growth (usatoday.com sees 43 million visitors each month), but it has not been sufficient to make up for the decline in the core business. We expect revenues to fall at a 5% annual clip during the next five years, and operating income to average 14% annual declines.

The New York Times Company NYT
Economic Moat: Narrow
FV Uncertainty: Medium
P/FV: 1.27

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