Hollywood Ending

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Be kind. Rewind.

The video rental motto might as well be the industry's mantra these days. Going back to happier times when folks were hanging out at the video store, picking out new releases, and laughing off late fees would be a welcome change of scenery for today's renting retailers.

Loaning out flicks hasn't been all that it's cracked up to be. Last night Hollywood Entertainment (Nasdaq: HLYW) warned that weakness in its rental business would smack this quarter's financials and carry over into early next year. While the stock is trading at less than 10 times its reduced annual forecast of $1.43 a share in earnings, investors are bailing before the closing credits have a chance to roll.

With Stocks 2004 now on sale, it wouldn't be right if I didn't point out how the company was the dud of Stocks 2003. Thankfully, eight of the other 11 featured stock ideas trounced the market, and the Hollywood Entertainment report did include a meaty sidebar on Netflix (Nasdaq: NFLX), which went on to more than quadruple over the past year.

So why is Netflix faring so well while Hollywood and market leader Blockbuster (NYSE: BBI) struggle? Perhaps it is the same DVD revolution that fueled investor interest in the sector in the first place. While the rental chains realized initial gains as they moved to the DVD format -- given the room for more inventory and the general excitement over the platform -- it appears that the consumer's appetite for the DVD has eclipsed the desire to simply rent it.

Packed with features and priced aggressively, DVDs are attracting more buyers than videotapes do. Really. While there are more homes with videocassette players than DVD systems, when Disney (NYSE: DIS) and Pixar (Nasdaq: PIXR) released Finding Nemo last month, 80% of the first day's sales were on DVD.

So how come Netflix has been spared the brunt of this rejection? Good question. It could be that the mail delivery convenience of the Netflix model is giving consumers the luxury to sample many releases before deciding on an outright purchase. The "all-you-can-eat" subscriber model also blurs the actual cost per rental with Netflix. At your neighborhood Blockbuster, you know you're getting billed $5 for a DVD that you have to come back to return, knowing that just $10 more at any other retailer would give you the freedom to own it forever.

As for Hollywood Entertainment, 2004 is already shaping to feature a scary opening. And warning about the holiday quarter just as the shopping season is starting doesn't make for a promising preview.

If you want to learn more about our best stock ideas for the year ahead, check out Stocks 2004. And if you're looking forward to many of the hyped movie releases coming out in the coming weeks and want to trade reviews and previews, visit the Great Movies discussion board. Only on Fool.com.