Investors Have No Business in Show Business

One of the bad things about a bull market is that the performance of mediocre stocks can look great when presented in isolation. Combine that fact with the willful neglect of the idea of the opportunity cost of investing–that is, you have to measure the success of an investment against other potential investments you might have made, not against “zero”–and you get a recipe for real confusion.

Take the very curious column by Roger Smith, Variety’s financial columnist, in the most recent issue of that magazine. In essence, Smith argues that entertainment has been a great business to be in over the last 15 years, that entertainment stocks have been often undervalued, and that they’ve been undervalued for one real reason: Wall Street is jealous of Hollywood, because people in Hollywood make lots of money and have fun doing it.

There are a lot of strange ideas packed into that argument. First, it assumes that Wall Street somehow controls stock prices. In the long term, it doesn’t. Markets collectively set prices, and markets are much bigger, and smarter, than all the investment banks and brokerage houses in the world put together. If the market has looked skeptically on entertainment stocks, it’s probably for a very good reason. And even if Wall Street did set prices, the idea that investment bankers have consistently foregone potential fortunes for themselves and their clients because their jealousy of Hollywood made them unwilling to buy or even recommend entertainment stocks is, at best, implausible. This is capitalism, remember? People who walk away from $20 bills that are lying on the street eventually disappear.

But there’s also a deeper problem here, which is that entertainment companies have not, in fact, been those proverbial free $20 bills. Smith points out that “the revenue side of showbiz” has risen dramatically at home and phenomenally abroad over the past decade and a half. But he doesn’t say anything about the profitability of showbiz as an industry, let alone about its return on invested capital (the most important single metric of a company’s economic performance). That’s because compared to industries such as software, telecom, networking, and pharmaceuticals, the performance of the entertainment industry has been anemic.

Besides, haven’t entertainment stocks been mediocre? Well, Smith mentions that Wall Street analysts often cite this point as justification for what he calls their “long-range myopia.” But then he shows–or believes he shows–that in fact big entertainment stocks have done very well in the past 15 years. Four–Disney, Comcast, Cablevision, and TCI–are up 20-fold, two are up better than 10-fold, a couple are up seven-fold, and a couple have “only quadrupled.”

Now, set aside the fact that of the real powerhouses, three are cable companies that own hard assets, not part of what we usually think of as “Hollywood.” Consider instead that since 1984, the S&P 500 Index is up better than nine-fold (and better than 12-fold since 1982). So most of the stocks that Smith cites have done about as well as or worse than the market as a whole. Then recognize that Smith is talking about the very best of the best here, and you start to see how weak the industry as a whole has been.

Twenty-fold since 1984? Between 1993 and 1998 alone, Dell’s stock rose 100-fold, AOL’s rose 35-fold, and Microsoft was up 12 times. Cisco, Sun Microsystems, EMC, Pfizer, Merck, MCI/Worldcom, Coke, Gillette, Wal-Mart, Home Depot, McDonald’s, even recent laggards like Nike: All of these stocks did as well as or significantly better than the best entertainment companies over the past 15 years (and many of them have been public for a significantly shorter period of time).

It’s not that entertainment isn’t a better business than it used to be. It is, mainly because the people running these companies are spending more time running them and less time thinking about how to make them bigger. But by the only standard that really matters–comparing how much money is put into a company versus how much money that company makes–entertainment is just not, and never has been, a good business. There are exceptions–Disney, Time Warner, CBS, USA Networks, TCI–but they are the exceptions. The bull market makes it easy to obscure that fact. But even in a bull market, the real numbers don’t lie. Of course, Smith is surely right that business in Hollywood is a lot of fun. Spending other people’s money always is.