How to Make a Portfolio of Media Companies

By Markets Fool.com

Media stocks can be good stocks for novice investors, since their brands are highly recognizable and their business models are fairly easy to understand. If you're setting out to build a portfolio of media companies, you'll want to keep the big-picture keys of investing in mind, including starting with more conservative stocks to build up your "core" holdings and only investing the money that you can afford to lose on more speculative plays.

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The media sector is filled with both conservative and speculative stocks. Traditional players like Disney are more conservative plays with time-tested business models, while newer streaming media players like Netflix are more speculative investments.

Let's discuss these two types of media stocks to help you understand which ones better fit your personal investing goals.

Source: Pixabay.

Traditional players
Disney, Time Warner , and 21st Century Fox are three of the largest media companies in the world.

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The key to understanding these media juggernauts is to recognize their most profitable properties. In addition to its parks, resorts, and first-party movies and TV networks, Disney owns Pixar, Marvel, and Lucasfilm, as well as ABC, ESPN, and numerous other cable channels. Time Warner owns Warner Bros. and cable channels including HBO, CNN, and TNT. Fox, which was spun out of News Corp. two years ago, owns the Fox film and TV studios, Asian pay channel operator STAR TV, and a stake in European pay TV company Sky.

Disney is outpacing both Time Warner and Fox on top- and bottom-line growth.

Annual Revenue Growth
(most recent quarter)

Annual Net Income Growth
(most recent quarter)

Disney

7%

10%

Time Warner

5%

(25%)

Fox

(17%)

(7%)

Source: Earnings reports.

Last quarter, Fox attributedthat slowdown to higher programming costs at its broadcasting division and a lack of a Super Bowl broadcast this year.Time Warner attributed its weaker bottom-line growth to higher film and advertising costs at Warner Bros. and rising expenses for original HBO programs such asGame of Thrones.

All three companies are vulnerable to weak TV ratings, box office bombs, fading franchises, and rising programming costs. Disney's ESPN -- which accounts for nearly a third of its revenue and over half of its operating income -- reported a 9% drop in profit last quarter due to rising costs for college football and NFL rights.

Game of Thrones. Source: HBO.

These media giants' continued growth depends on their ability to keep profitable franchises churning along for years with reliable returns. Disney excels in that department. Its Marvel Cinematic Universe has been mapped out until 2019, and it is expected to expand the Star Wars Universe with new spinoff films, theme park attractions, toys, and video games. Time Warner and Fox simply don't have as many ways to maximize a popular franchise's profitability.

Streaming media stocks
Whereas traditional media companies produce most of their own content, streaming media companies includingNetflix and Pandora Media produce very little original content and instead pay content providers for broadcast rights, charge subscription fees or earn revenue from advertisers, and hope there's enough left over to turn a profit.

Due to rising content prices, streaming profits are usually slim. Last quarter, Netflix's revenue rose 31% year over year to $1.4 billion, but net income plunged 55% to just $24 million. From the first quarter of 2014 to the same period this year, Netflix's streaming content obligations -- the amount the company promises to pay film and TV studios -- rose 38% to $9.8 billion. To keep those costs under control, Netflix is producing more original content, but some of these shows are exceptionally pricey. Marco Polo's first 10-episode season reportedly cost $90 million, making it the second-most-expensive TV series in the world, after Game of Thrones.

Netflix's Marco Polo. Source: Netflix.

Pandora's streaming radio business faces the same challenges as Netflix. For every song that listeners stream, it must pay royalties to record labels. Last quarter, those royalties gobbled up 55% of Pandora's revenue, resulting in a net loss of $48 million -- compared to a loss of $29 million in the prior-year quarter. Like Netflix, Pandora is expanding intooriginal content to offset those costs, but it could be tough to persuade listeners to tune into the company's programs instead of mainstream music.

Netflix and Pandora are also vulnerable to disruption by tech giants Amazon.com, Google, and Apple, which can charge lower prices and use streaming media as a loss leader to expand their ecosystems. Large media companies with new streaming apps -- like Time Warner's HBO and CBS -- could also lure away Netflix subscribers.

HBO Now. Source: HBO.

The takeaway
In my opinion, risk-averse investors should stick with big established players like Disney or Time Warner, which generate fairly stable earnings growth and reward long-term investors with dividends. Nonetheless, these stocks remain vulnerable to rising programming costs and unstable box office returns.

Streaming companies like Netflix and Pandora might grow their top lines at a faster rate than traditional media companies, but their profitability will be weighed down by content acquisition costs unless they can produce enough original content. But if they do, they could evolve into larger media companies and reward investors who were able to ride out the volatility.

If you're building a portfolio of media companies, be sure to understand your tolerance for volatility and risk as you look around at the companies behind your favorite television shows and movies for inspiration on where to put your money.

The article How to Make a Portfolio of Media Companies originally appeared on Fool.com.

Leo Sun owns shares of Apple and Walt Disney. The Motley Fool recommends Amazon.com, Apple, Google (A shares), Google (C shares), Netflix, Pandora Media, and Walt Disney. The Motley Fool owns shares of Amazon.com, Apple, Google (A shares), Google (C shares), Netflix, Pandora Media, and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.