December 17, 2012 - Tuning into Profits During the New Year
Two thousand and twelve is wrapping up and the next year will be here before you know it. In the stock market, 2012 was not really such a bad year. The major indices are up 10% and there were some areas where we had both long up and down stretches. The economy is weak with high unemployment, but seems to be recovering. Just like everyone was burned out with election coverage, the financial troubles of Europe and political bickering took their toll on people. We are not to the New Year yet, and Congress and Obama are still working on a plan to avoid the Fiscal Cliff. Progress on an agreement seems to be meager at the moment, with neither side offering up much of a compromise. I expect a compromise will be reached, but it seems that politicians are always waiting till the last minute to pass plans.
The Fiscal Cliff involves large tax increases and some spending cuts. If we went off the cliff, it would not be the end of the world. Going off the cliff would cut the US government deficit in half overnight and may lead to a couple of quarters of recession before an expected recovery later in the year. Long-term government deficits need to be addressed and, while everyone would like to grow out of an economic slowdown, that has not been working real well. The US debt-to-GDP ratio has been climbing significantly and represents a grave long-term threat, while the Fiscal Cliff is more of a short-term effect.
If worse comes to worst and we do actually go over the fiscal cliff, it might be good for us in the long term. By taking our hits now, things would improve later in the year. The world of politics can be complicated, and while one may believe that short-sighted politicians did not see the fiscal cliff coming, one also might believe that they deliberately created it. In the long term battle for government and taxes, Democrats definitely have an advantage with automatic tax increases coming. Timed after an election and with two years until the next one, it might be the best politicians can hope for, with incoming politicians able to blame predecessors and enough time that the economy could be recovered by November 2014 elections.
Every family goes through good and bad times. To a teenage girl who may suddenly realize that she is going to lose her car or her credit card, or both -pity her soul- the world seems like it is coming to an end when a family tightens its budget. Instead of shopping at the mall, she will need to find other more economical hobbies like cooking at home. It may have seemed like her world was going to end, but like the Mayan calendar in 2012, it didn't. If we do go over the fiscal cliff, people might think the world will end, but it won't.
Another reason that the politicians like to do short-term tax cuts is that by showing tax increases down the road it gives a rosier budget forecast. The congressional budget office puts together economic estimates of taxes and spending going out several years. Temporary tax cuts have been easier to get through and politicians get political credit every time they extend them. Also each side in the negotiations needs to show its constituents how hard they are working and if they come to an agreement to early it might look like they should have fought longer. If this is the case, a solution will be reached. Regardless of how this politically-made crisis turns out, the sun will rise tomorrow on America -- a land of freedom and opportunity.
The real winners through the political season may well be the media companies who are covering the latest drama every step of the way. With all the political spending this year on TV, billboards, radio spots and more, the media companies have pulled in a lot of revenue. As the drama continues to unfold and you tune in every night to see the latest in the negotiations, media will still be doing well. If you get frustrated enough to flip the channel, chances are the media is making money there, too.
CBS (CBS) is a diversified media company competing with the likes of Disney (DIS), News Corp (NWS) and Time Warner (TWX) that have been doing well recently. The stock has a Five STARS S&P rating. Revenues for 2012 should grow 6% while revenues for 2013 are expected to grow 7.5% to $16.2 billion. While the CBS brand television network is the most visible of the company holdings, it also owns CNET, Simon and Schuster publishing, Showtime Networks, 130 radio stations, local TV stations and more. The company employs 26,000 employees in five business units. Entertainment makes up 52% of revenues, while cable (11%), publishing (5%), local broadcast (19%) and outdoor billboards (13%) make up the rest. Earnings heavily dependent on advertising took a dip with the financial crisis in 2008 but have been recovering well. The company is expected to produce earnings of 2.60 this year, up from 1.90 last year and 1.04 in 2010.
The stock is trading near 35 and has been in a steady upward trend from the 20-range two years ago. The company has spent 1.7 billion in the last two years buying back stock, a program it recently replenished to continue. This should help support the stock price. There are class A and B shares giving about 75% of the voting power to Sumner Redstone's companies, which many analysts don't consider ideal; but the stock has been performing well.
Media is an ever shifting business. DVRs, on-demand TV, and cable subscription fees have made a dynamic environment, but one in which CBS has been able to prosper. A long-term trade that will take us through any temporary dips in the New Year and target a healthy return rate looks promising.
Take a look at a covered call on CBS. An investor can buy the stock and sell the January 2014 35 call for a 31.05 net debit, which will give us about a 13% simple return. The trade has about 13% of downside protection with an annualized return rate near 12%. (This trade is held for more than a year so the annualized return is less than the simple return rate,) The stock pays a dividend yield of 1.3%.
While a major downturn in the economy could affect CBS revenues, the company is doing very well in a less-than-ideal environment already. While the politicians squabble, an investor in the media companies can profit on a large stable diversified media company with a trade that will take you all the way through next year.
Chart courtesy of stockcharts.com.