Media stocks have performed terribly, but we think they will rebound.
At Morningstar, we spend a lot of time with great investors. Our favorites tend to buy and hold great companies at bargain prices. We realize, however, that there are lots of ways to make money in the stock market, including by buying stocks solely because they have fallen out of favor. The theory behind this approach is that stocks always revert to some mean valuation level, and stocks that have experienced sustained price and valuation declines will eventually enjoy gains that will move their valuation ratios up to the mean.
If this style of investing makes sense to you, then you might want to spend some time evaluating stocks in the media sector. Over the past five years, Morningstar's index of media stocks has dropped more than any of our 12 sector indexes: negative 3.49% annually (including dividends), compared with a 4.33% total return for the S&P 500. Almost half of the 83 stocks in the index with five-year records had negative annual total returns during this period. Subtracting dividends, this percentage decline would be even worse.
Lest you think that the media sector's underperformance is limited to just the past five years, a quick glance at our sector performance tables shows that the media sector has been the worst-performing sector--according to Morningstar's market-cap-weighted sector indexes--in every time period we calculate. As of March 20, the media sector was dead-last over the five-day, year-to-date, one-month, three-month, one-year, three-year, and five-year periods. Needless to say, the media sector has presented numerous humbling experiences to our team of analysts--and many highly respected investors--over the past several years.
We suspect that future returns for media stocks will be much better than those of the recent past, however, and we're not just saying this because the past several years have been so bad. Our argument is also supported by the Morningstar Ratings for stocks and our fair value estimates, which are grounded in discounted cash-flow valuation. Of the 60 media stocks that we cover, 40% of them have ratings of either 4 stars or 5 stars, while just 15% have 1- or 2-star ratings. The media sector has more undervalued stocks (as a percentage of the total stocks in the sector) than any of our 12 sectors.
One of these 5-star stocks is a media-sector favorite of ours: The Washington Post Company
Washington Post isn't the only company with roots in the newspaper business that looks attractive right now: Six of Morningstar's eight 5-star media stocks operate in the newspaper industry. Newspaper stocks have been pummeled recently due to concerns that the Internet will make newspapers obsolete. While we appreciate that the Web has changed many of the rules in the newspaper publishing game--and reduced the inherent competitive advantages of newspaper publishers--we're not ready to count newspaper publishers out just yet.
We actually believe that in a world filled with way too much information--much of it inaccurate--delivered via more media and channels than any one consumer can possibly manage, the editorial skills found in the newspaper industry could prove to be very valuable. Study after study has shown that the average consumer actually doesn't like to have too many choices, which is exactly what the Internet provides. In the long run--and recent research suggests that this has already started--consumers will gravitate to a handful of trusted information sources for their news.
We suspect that newspapers like The New York Times, The Washington Post, and The Wall Street Journal will benefit from this, as will local newspaper publishers. To this end, newspaper publishers have been allocating significant amounts of capital in recent years to make their Web sites attractive destinations. They have also begun to partner with high-traffic sites like Google and Yahoo in order to drive more consumers to their news. By employing some tech-savvy and embracing new business models, newspaper publishers with strong brands and topnotch content may actually thrive in an increasingly fragmented media landscape.