Wednesday, December 31, 2008

From The Mailbag: New York Times

Stock in The New York Times Company (NYT) has dropped 90% from its high and 60% in the last year. While the stock is undoubtedly trading for far cheaper than it was, this is a great example of a value trap.

While the company owns a stable of recognized brands (including part of the Boston Red Sox), its flagship newspaper business is clearly in secular decline. (You can see this by reading the company's "segment" disclosures on its annual reports.) Newspapers are no longer the stable city-wide monopolies or oligopolies they once were. Every year, more and more advertisers shift towards more targeted forms of advertising, and readers are migrating to news sources with faster distribution channels. While we often advocate estimating a company's earnings power based on an average of past earnings, this would result in an overestimation of the earnings power for a company in secular decline. This makes it very difficult to determine a floor for the earnings power of this company.

At the same time as its business is in decline, NYT is working with a burdensome debt load. This further adds to the uncertainty with respect to the company's future. While the company's debt to equity ratio above 140% would be just ok if the company still operated as a relative monopoly like it did in the decades before the internet, it has now become quite a burden. Operating earnings over the last 5 quarters have not even been sufficient to cover interest payments; therefore, it's difficult to see how shareholders are going to be able to reap much in the way of benefits.

While value investors like to buy companies with great brands and steady track records, one has to be on the lookout for signs of trouble ahead. For us, companies whose business models are out of date and which are further burdened by high debt loads are not worth the risk of investing in.

Other examples of value traps include GM and Ford of 2004, which we wrote about here. Value investors who were paying attention at that time would have seen a strong chance of the collapse which is currently taking place.

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