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Rule #1 and the Movie Industry

Phil Town
Phil Town

I recently corresponded with an acquaintance who works in the film industry and who is just getting started looking for a wonderful company. This is what I told her:

Let's go through finding a good stock in a good industry that we know something about:  movies.

Go on Yahoo, click Finance, click Investing, click Stocks, then clickSector/Industry Analysis (under Analyst Research).  You'll get a list of 9 sectors.  All stocks are in one of these.  Under Sector, click Services.  You'll get a list of Industries in the Services Sector.

Click on Movie Production.  You'll get a list of all the movie production companies that sell their stock to the public.  Now look at the matrix of numbers to the right of all those company names.  See the heading ROE%?  Only bother with businesses that have at least a 10% in that column.

The rest of them are basically crap.  The list gets short quickly.  DreamWorks, Lions Gate, Marvel, New Frontier, Regal, Rentrak, Valcom.  Seven businesses that might not be horrible to own.

Note the symbol for each.  If it has a .OB after it, forget it.  Too small and too dangerous to buy.  Scratch Valcom.  Now you have six.

You are looking for the best business in the industry to invest in, so you have to narrow it down to one -- so we're going to screen these to see which one of the six, if any, is a Rule #1 business.

The essence of a Rule #1 business is that it is a good enough business that we can actually figure out what it's worth.  If we can't do that, how are we going to know if we're paying a fair price?

We can see the price by looking at the market any day, but its price is often not what it's worth.  The problem is, many businesses are too inconsistent to know what is going to happen in the future.  So let's see if we have any movie businesses that are consistent enought to make a prediction about whether they will be around in 20 years.

Start with DreamWorks.  Open another window and go to another website.  Click on Money.  Click on Investing.  Click on Stocks. (Click on the line that says "upgrade to MSN Money toolset" or something like that if you don't see the info I'm talking about.)

In the space type in DWA -- the symbol for Dreamworks.  In the left column click on Financial Results.  Click on Key Ratios.  Click on Investment Returns. Look at Return on Capital.  9.6%.  Not 10%, but close enough.  Click on Ten Year Summary.  Look at Book Value/Share.  We'd like to see it go up steadily.  Instead it goes from $2.20 to -0.15 to $8 to $9.  Not great.  Onward.

On the left click on Statements.  Click on 10 Year Summary.  Look at Sales.  Start 5 years ago with 661 mil, then dropped two years in a row then up to a billion then dropped to 460.  Sheesh.  Pretty much not so consistent top line.

Now bottom line.  Look at EPS.  1.56, then two years negative the 4, then 1.  Ouch.  We could go farther but I'm done with this one.  It's way too soon to tell if this is going to be a long term great business.  No way to predict if Dreamworks will be around in 20.  But if we were to continue on, I'd click on Cash Flow.  Look at the Cash From Operating Activities.  See the red numbers?  Not good. Actually very not good.  You want a business that produces cash, not eats it.  I would never invest in this one unless they were giving it away for the cash in the bank.  Then, maybe.

So that's the Big Five Numbers:  ROIC barely okay.  Book Value, Sales, EPS and Cash inconsistent.  So Dreamworks is an unpredictable business.  No way to know what it will be worth someday down the road. So no way to know what I should pay for it today.  The fact that the market is pricing it at $2.9 billion is sort of a mystery.  Obviously it has some value.  It has some good movies that it can resell.  It's going to make good ones in the future.  But this is a crap shoot.  It might have a $2 billion net earnings next year and look like the best deal in the world.  Or it could lose a billion.  Not what we are looking for, really.

I just took a quick look at Lions Gate.  Terrible Return on Invested Capital.  End of story.  But the rest of the big five were bad too.

Marvel?  Pretty consistent last five years.  But last year wasn't so great.  And it's getting worse.

New Frontier.  more of the same inconsistency.

Regal.  Theaters.  But still not good.

Rentrak.  Well.  Some consistency.  Not great.  Not much of a grower. And in the DVD rental biz.  Which may be just about ready to disappear.

So that's it for the movie production group.  Nothing consistent, which tells you that the movie production business is not the place to look for a consistent long term investment.  (However, there are some big guys that aren't in here, like Disney, that we can still look at.)  But in this group, nothing looks like it's worth messing with.  This isn't to say that some of these won't do well for investors... just that we can't have an opinion about it without knowing a whole lot more about these businesses.

For example, Regal owns theaters.  Maybe if we dig in and find out what all that real estate is worth, this is a steal. But you better know what you are doing, bucko, if you are buying businesses with these inconsistent results because of the value of the assets.  By the time the business gets around to selling off the assets for the investors there may be no assets to sell.

So that's how I do it.  Now do that for every industry you know something about.  After about ten hours of messing around like this, you'll have found your first good stock.  Find 4 or 5 and you are done.  After that it's about 15 minutes a week.

Now go play!


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