Last week, shares of Time Warner Cable (NYSE:TWC) were up big again, after further speculation that the company could merge with Charter Communications (NASDAQ:CHTR). It was just the latest catalyst to drive shares of the cable provider group, which also includes potential acquirer Comcast (NASDAQ:CMCSA), higher. However, while these stocks have had a great year, it's probably in your best interest to avoid the entire group right now.
Here are the three biggest reasons you should steer clear of cable.
Reason 1: A false sense of security
I rarely, if ever, feel the need to write a piece that urges people to avoid a stock or a sector. Since the information regarding the risk of any given sector is usually common knowledge, I tend to believe that the market generally operates efficiently and prices stocks with high risks accordingly. Yet there still are cases where Mr. Market gets it wrong, by not panicking enough, and that is the sum of my fears with the cable sector.
Of all the misunderstandings that investors have about this sector, perhaps the most worrisome is the idea that it is "safe." There are reasons, regarding the future of these businesses, that make this idea false, but let's start with the numbers. Most investors who view these stocks as safe view them as such because they have good dividends and seem like they'd be steady growers.
While their dividends have been fairly stable, Comcast and Time Warner actually both have dividends under 2% -- below the average payout of all S&P 500 companies. All three of these companies are trading near 52-week highs; Time Warner and Comcast both trade around 20 times earnings; and Charter hasn't turned a profit in years. The real reason that these companies seem safe is that they're all we've ever known when it comes to home entertainment.
Furthermore, the idea of investing in an individual stock simply because it seems "consistent" or pays a dividend is fundamentally flawed. You can buy an index of dividend stocks, or blue chips, with far less risk in many funds and ETFs. In my opinion, when you're putting your real money behind a company that could go belly-up -- and every company could -- you should believe it is on the cusp of big things.
Reason 2: TV, and cable, viewership is declining
The traditional TV business model is at the beginning of a fundamental decline. If you disagree with me on this fact, then you very well may decide to hold on to shares, but just know that even Time Warner CEO Glenn Britt has admitted the industry is in "denial" over the challenges from digital entertainment.
The variety of sources that we get entertainment from is expanding, and thus, so is competition for traditional cable providers.
This fascinating article from Business Insider showcases the data that points out how vast the threat to TV, and cable, from digital and mobile viewing is. In the article, we see that TV's market share of U.S. media consumption has declined by 7% in just four short years, and that fewer households even have a TV. All the while, since 2010, the number of new cable subscriptions has declined by more half a million, yet shareholders remain blissfully unaware or unfazed as they push all of these stocks higher.
What all of these companies represent is a potential trap. We, the viewing public, have known the "consistency" of television and cable for decades, but it faces some serious challenges today. While I don't believe the traditional TV will ever go away, I do believe that content from digital and mobile sources will splinter advertising dollars and hinder these cable providers' growth.
Reason 3: The M&A catalyst
It's worth noting that Comcast does have other non-cable businesses such as NBC that provide original content. That makes Comcast much less risky than Charter and Time Warner, and even companies like DISH Network, but I wanted to include it in this discussion for two reasons.
- Comcast still earns the majority, 65%, of its business from cable and Internet subscriptions.
- Comcast has been mentioned as the second, and perhaps preferred, suitor to acquire Time Warner Cable.
I don't know who is purchasing Time Warner; it could be Comcast or it could be nobody. The point is, nobody knows, and any catalyst based on these rumors is pure speculation.
The fact that these stocks, especially Charter Communications, were up on this news last week is very troubling. In Charter Communications you have a business that went bankrupt a few years ago, and has been largely unprofitable since, up more than 60% this year on speculation of a merger. That's pretty risky fare, especially when you consider the merger would just be buying into another potentially declining cable business, and not an original content provider (e.g., Comcast buying NBC). Sure, a merger would consolidate competition and improve margins, but that might be a wash with increased digital competition.
Foolish conclusion: Invest in tomorrow
I feel that the best investments are born when great businesses meet the game-changing trends of tomorrow. The only recommendation I can give is to limit your individual stock picks to a few select businesses that meet that criteria.
In other words, if you believe that cable TV will withstand a mobile onslaught of competitors unscathed, or if you really believe in the management team at Charter Communications, then you may want to hold on to your shares. But if you don't feel that way, or if you aren't sure in either case, you may want to consider selling your shares.
There's nothing wrong with taking a profit now, and avoiding an uncertain future.
Fool contributor Adem Tahiri has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.