Media Stocks' Lows Could Hold for a While

Back on Sept. 29, I published a column titled "Downside for Media Stocks is Still Looming." Little did I know that a tsunami was about to hit the market that would be particularly tough on media stocks.

As you can see on the chart below, since that day, the big five media stocks are down an average of 39% against a drop of 30% for the S&P 500. Four of the five media stocks have underperformed, and Disney (DIS - commentary - Cramer's Take) has not exactly been a champ, as it has matched the market's fall.

A comparison of current consensus estimates with those on Sept. 29 shows that estimates have fallen by about 20%. With stock prices down twice as much as consensus estimates, a significant part of the stock price declines is due to multiple contraction. For Disney and Time Warner (TWX - commentary - Cramer's Take), the multiple contraction has accounted for most of stock price decline, as consensus estimates are down just 4% and 9%, respectively.

An explanation for the contracting price-to-earnings ratios can be found by looking at the change in the low estimates. The average change in the low estimate in the past two months has been 23%. Only Time Warner has shown any stability in estimates, with its low estimate down just 6%. It appears as though investors are assuming that the rapid deterioration in the economic outlook will cause the companies to miss consensus and that the low estimate is a more realistic outcome.

This is a reasonable assumption, given that at the margin advertising is a discretionary expenditure. Advertising budgets won't be eliminated completely, but budgets can be cut. The current advertising downturn is being exacerbated by the fact that two of largest advertising industries are two of the sickest industries: autos and financials.

Click here for larger image.

Source: Raw data from Yahoo! Finance

Media stocks are caught in bind. The largest single driver of revenue - advertising -- is under pressure, with the biggest advertisers feeling the most intense pain. Furthermore, advertising expenditures have low visibility, so predicting future revenue is difficult. Put it all together, and you have stock prices falling faster than earnings estimates as investors assume the worst.

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At time of publication, Birenberg was long Time Warner in personal and client accounts, although holdings can change at any time.

Steven Birenberg is president and chief investment officer of Northlake Capital Management, LLC. Northlake specializes in managing equity portfolios using a combination of exchange-traded funds and special situation stocks. Birenberg appreciates your feedback; click here to send him an email.