Throw This Stock Away

The house rules are simple in this weekly column.

  • I bash a stock that I think is heading lower.
  • I offset the sting by recommending three stocks as portfolio replacements.

Who gets tossed out this week? Come on down, DreamWorks Animation (NYSE: DWA  ) .

Shrek the hauls
Shares of DreamWorks Animation are trading higher today, after the computer-animation specialist posted blowout quarterly results.

Earnings more than doubled to $0.47 a share, well ahead of the $0.35 a share that analysts were targeting. Revenue soared to $188.9 million. The pros were banking on $163.1 million on the top line.

The overseas success of Shrek Forever After -- the fourth and presumably final installment in the franchise -- fueled the healthy showing, but the company's financials are always as lumpy as Shrek's toadstool stew.

Take a step back, and you'll see that DreamWorks isn't the growth stock you think it is. During the first nine months of 2010, revenue has declined by 4%. Earnings of $0.98 a share are a lot less than the $1.23 a share it rang up during the first nine months of 2009.

I'm a fan of many of DreamWorks Animation's flicks. I was also a shareholder for a couple of years -- until I got fed up with all the stock's ups and downs, which ultimately led nowhere.

It's true that Shrek Forever After was an international hit, ringing up twice as much in ticket sales abroad as it did domestically. However, it was a dud at home.

Scoring just $238.4 million at the box office in this country, it was the lowest-growing installment in the Shrek franchise -- and even more of a disappointment when you factor in inflation and the hot trend of premium 3-D and super-sized screenings. This summer's Despicable Me -- not a DreamWorks Animation film, by the way -- had a healthier stateside run.

And that's another problem. Outside of Pixar, there isn't a computer animator with a distinctive niche. Megamind opens next week. Do you know the studio behind it? Well, it happens to be DreamWorks Animation, something that few outside of its shareholders may be able to appreciate and differentiate.

I don't think Megamind will be a bomb, but the way studios have been bellyaching about softening DVD sales and marked-down rentals, there's a lot of pressure for new franchises to succeed in their theatrical runs. I'm not sure if I want to be the one holding shares of DreamWorks Animation on the other side of Megamind's opening weekend.

DreamWorks Animation isn't exactly expensive. The current quarter should be a good one, with Shrek Forever After hitting the DVD market in December. The stock is also trading for just 16 times next year's projected profitability.

However, this company will continue to take shareholders on a ride that doesn't go very far. The stock went public six years ago at $28, closing at $38.75 on its first trading day. Where do shares trade now?

Are you up for another roundabout journey to nowhere, or do you somehow think that Megamind will be the next Shrek juggernaut?

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.

IMAX (Nasdaq: IMAX  )
During last night's call, DreamWorks Animation CEO Jeffrey Katzenberg pointed out that 60% of Shrek Forever After viewings were in 3-D, where audiences pay a more than $3 premium per ticket. This is naturally good news for RealD (NYSE: RLD  ) , the country's largest 3-D screen outfitter, but IMAX is the better global play on premium cinematic experiences. IMAX has announced 199 new theater signings worldwide this year, far more than the 35 it inked all of last year. It reports quarterly results tomorrow, and analysts see a fivefold pop in profitability.

Disney (NYSE: DIS  )
Disney's Pixar knows how to milk a franchise. Toy Story 3 was a far bigger hit than Shrek Forever After this summer, raking in $414.8 million at domestic multiplexes. It rang up greater ticket sales than Toy Story 2, which in turn outsold Toy Story. It's a safe bet to assume that Pixar's Cars sequel will also top the original next summer. Disney is also trading at a cheaper earnings multiple than DreamWorks Animation -- without the lumpy earnings.

Netflix (Nasdaq: NFLX  )
The optical disc's slow fade is hurting studios, but opportunities in digital delivery abound. Google's (Nasdaq: GOOG  ) YouTube runs the world's most popular video-sharing site. A consortium of media heavyweights including Disney, Fox, and General Electric's (NYSE: GE  ) NBC Universal watches over Hulu -- the syndicator of choice when it comes to network content. But despite all this competition, Netflix still looks like a champ.

Mailing out DVDs may still be its bread-and-butter business, but two-thirds of its 16.9 million subscribers are now streaming content from Netflix's growing digital library. Shares of Netflix aren't cheap at these levels, but this is the one play that will be able to eventually cash in on hot animated releases streamed digitally -- whichever studio happens to be doing the computer rendering.

I'm sorry, DreamWorks Animation, but I think you and your ogre deserve to remain stuck in the swamp.

Walt Disney and Google are Motley Fool Inside Value choices. Google and IMAX are Motley Fool Rule Breakers recommendations. Walt Disney, DreamWorks Animation, and Netflix are Motley Fool Stock Advisor picks. The Fool owns shares of Google. 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.

Longtime Fool contributor Rick Munarriz doesn't mind taking out the garbage every so often. He does not own any of the stocks in this story, except for Disney and Netflix. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


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  • Report this Comment On October 28, 2010, at 12:26 PM, jmbring wrote:

    thanks for the great article Rick, spot on.

    mark

  • Report this Comment On October 29, 2010, at 12:22 AM, esxokm wrote:

    I clicked on DWA for your poll. The reason? You have to consider the issue of a buyout. Presumably that will happen at some point.

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