Why return of capital led to a media stocks boom (Part 1 of 4)
Media stocks take off
Television content producers have experienced an impressive year. As we saw in the series Must-know trends from the Netflix boom, the value of the content these companies produce has climbed quickly, reaching growth rates of 10% or more per year. The results have put the shares of many media companies on a tear of late. Over the last 12 months, shares of Disney (DIS), Viacom (VIAB), Time Warner Inc. (TWX), and CBS (CBS) have returned between 40% and 65%. CBS, Disney, and Timer Warner are members of the PowerShares Dynamic Media ETF (PBS), which provides exposure to an index of media companies. Viacom is a member of the PowerShares Dynamic Consumer Discretionary Sector ETF (PEZ).
Cash is king
With their strong operating performance and valuable assets, media companies have been able to generate robust free cash flow. Investors are attracted to cash flow because it implies economic health and can be used to either reinvest in growth projects or provide returns to shareholders in the form of dividends and stock buybacks.
Free cash flow (or FCF) is typically defined as “cash from operations minus capital expenditures.” The amount of FCF that a company generates can be used to reinvest or pay down debt, or it can be returned to shareholders. Investors often look at FCF yield, or FCF per share divided by the share price. This makes a stock comparable to a bond, as the FCF can be considered synonymous to a bond’s coupon payment.
The chart above depicts the FCF yields across the four companies, which ranges between 6.6% and 11.8%. We can compare the yield with the yield on a U.S. Treasury bond of only 2.8%. Investors’ expectations for the deployment of this cash have been a central driver for the stocks’ performances. Continued FCF generation will be able to sustain these companies’ appeal to investors.
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