10 Dying Industries, 3 Vital Stocks

Research firm IBISWorld recently published an analysis of 10 "dying industries" -- industries that are in structural decline. Do you own stocks in any of those industries? That needn't be cause for concern. Yes, the industries are contracting, putting pressure on company earnings; however, other factors can still create opportunity for value-conscious investors. I'll explain why and identify three stocks that look attractive relative to the overall market.

10 terminal patients
In case you're curious, the following table contains the 10 dying industries, along with annualized industry revenue growth over the past 10 years:

Source: IBISWorld.

I'm assuming there aren't too many surprises on that list: When was the last time you set foot in a record store? Fundamentals aren't good in these industries, but does that translate to their stock market performance? I looked at the 10-year performance of the 29 stocks traded in six of the 10 industries in the table above (U.S. companies with stocks traded on major U.S. exchanges and a minimum market capitalization of $500 million). The results might surprise you:

Total Return, Annual (to April 7, 2011)

Source: Capital IQ, a division of Standard & Poor's. I looked at just 6 of 10 industries identified by IBISWorld because the other four were too specific for the industry classification in my screen setup.

Where the dying beat the average
In every period I looked at, our dying industry basket outperformed the S&P 500! It's worth noting, however, that the results don't account for survivorship bias. Last week, DISH Network bought Blockbuster's assets out of bankruptcy. The video rental chain was not included in the basket (no shares traded on major exchanges). Needless to say, if it had been, it would not have contributed positively to returns.

That said, let's look more deeply at three of the industries.

Wired telecommunications: AT&T (NYSE: T), Verizon (NYSE: VZ)
When an industry undergoes a tectonic shift like the one that continues to sweep through the fixed-line telecommunications business, companies can adopt multiple strategies. The incumbent major telecoms had a bit more breathing room in terms of developing a response, because their franchises were still generating massive profits, giving them time and resources.

Still, both AT&T and Verizon have trailed the S&P 500, with annualized 10-year returns of 1.4% and 3.1%, respectively, against 5.2%. Does that mean that they will start to outperform over the next several years? Both sport rich dividends in excess of 5% that will contribute handsomely toward that goal, and they look like acceptable investments in an overheated market.

Apparel: Hanesbrands (NYSE: HBI)
Hanesbrands is an example of a business that operates in a bad industry, but which possesses some advantages that ensure it will resist the headwinds better than many of its peers. Scale, for example, enables it to extract a cost advantage over its competitors.

Since Hanesbrands' shares began trading after its 2006 spinoff from Sara Lee, they have soundly beaten the index, with an annualized total return of 5.8%, beating the S&P 500 by almost 8 percentage points. Going forward, I think Hanesbrands will continue to provide acceptable returns.

Newspaper publishing: The New York Times Co. (NYSE: NYT), Washington Post (NYSE: WPO), Gannett (NYSE: GCI)
Once a stock is tarred with the "terminal industry" label, investors will often dismiss it out-of-hand; thus, they are slow to pick up on changes and improvements in the business. For example, is the Washington Post a newspaper company or is it an education company? It might surprise you to learn that the company derived 60% of its 2010 profits from its education segment.

At the 2006 Berkshire Hathaway (NYSE: BRK-B) annual meeting, Warren Buffett said newspaper stock prices didn't reflect the probable rate of earnings decline. He was right: The stocks have performed abysmally over the past five years. Today, the stocks are roughly a third to one-half cheaper on the basis of their earnings multiples. Gannett looks most attractive to me, but none of the three get me in a lather.

Ugly industries can produce beautiful stocks
Businesses in bad industries don't necessarily make bad stocks. Finance academics have identified a "value" premium (i.e., value stocks with low P/E, low price-to-book-value multiples outperform high P/E, high price-to-book-value "growth" stocks because investors tend to overpay for growth). I think the same bias toward growing industries versus industries that are in decline may create opportunities in the latter to collect a similar premium. The next time you catch yourself thinking, "I'd never invest in this stock: The whole industry is going down the tubes," think twice. The key question is not "What does this business do?" but rather "How much residual value am I getting relative to the price I'm paying?"

I believe AT&T, Verizon, and Hanesbrands provide enough of this residual value from here. If you'd like to track these three vital stocks using My Watchlist, click here. You'll get valuable updates as well as immediate access to a new special report, "6 Stocks to Watch from David and Tom Gardner." Click here to get started.