New York Times: It's Cheap for Good Reason

In the world of small-cap investing, it's often difficult to pass up familiar names. It's an emotional tendency to think, Why buy some stock we've never heard of when we can pick up shares of a product we know and love?

I have to admit that the recent decline in shares of New York Times (NYT Quote) generated an immediate hope that it might be time to turn bullish on the publisher.

Didn't we know that the publishing sector was bad last summer? Didn't we know that newspaper fundamentals were weak when New York Times was trading at $25? Didn't Warren Buffett do well by buying a large stake in Washington Post (WPO Quote)? Doesn't the New York Times fit in the best-of-breed category?

The answer to each of these is a "yes" -- followed immediately by a "but."

One of the easiest ways to start a bullish argument for the New York Times is by focusing on historical metrics, such as the strength of the Times' brand or the stock's price/earnings multiple. The problem, however, is that the media landscape has changed so drastically over the past five years that, from an investment perspective, the historical metrics just aren't useful.

Also, with a U.S. recession in 2008 looking more likely with each new economic data point, the near-term future of the newspaper industry becomes even less attractive regardless of how cheap the stocks look.

It's true that New York Times stock looks cheap at about 13 times 2008 consensus earnings estimates, but even with the company cutting costs and respectable growth in its About.com segment, earnings are expected to grow just 6.5% in 2008. I expect this growth rate to move closer to zero as many analysts lower their estimates over the next month to account for an increased slowdown in ad sales due to economic pressures.

Based on what we've seen during the first three weeks of 2008, no multiple is safe in the current environment as the existing estimates (for all public companies) are mostly based on the outdated view that 2008 would be a modestly positive year on the macroeconomic front.

Besides, it's incredibly difficult to confidently declare the appropriate multiple for a declining business. As I mentioned before, it's no secret that fundamental trends in the newspaper industry have been poor in recent years, but there's still a perception that the brand name and content have significant value.

You'll often hear the phrase "content is king" thrown around when discussing media plays like the New York Times, but I'd point out that there's more content than ever spread out across a number of media outlets -- from the free newspapers handed out at nearly every subway station in New York City to the infinite postings of the blogosphere. Even the historically profitable classified business is slowly being rendered obsolete by Web sites such as Craigslist and Monster.com.

Beyond the shares being cheap, the most enticing feature of New York Times' stock is its quarterly 23-cent dividend. With the Fed cutting rates, a dividend yield above 6% becomes even more attractive. Unfortunately, despite the fact that the company raised the dividend less than a year ago, it's unlikely to remain as high when one considers the difficult industry trends and around $1 billion in debt on the company's balance sheet.

David Peltier, our resident expert on dividends at TheStreet.com, pointed to the danger of buying shares of the New York Times for the dividend almost a year ago, and he still sees little hope for its sustainability.

Finally, if you're looking to emulate Warren Buffett's purchase of a large stake in the Washington Post, you need to reread Buffett's principles of investing. Remember that Buffett focuses on fundamentals and companies with predictable cash flows. In the mid-1970s, the newspaper business was extremely predictable, and Buffett could look at the Washington Post as a sum-of-parts story. (The company also had a number of TV and radio stations as well as Newsweek magazine.)