“The VCR is to the American film producer and the American public as the Boston strangler is to the woman home alone.”

The late Jack Valenti was the legendary head of the Motion Picture Association of America (MPAA). He ran the MPAA from 1966–2004.

Valenti made the above statement to Congress in 1982. He wanted lawmakers to “regulate” (prevent) the import of VCRs into the United States.

The movie industry feared people would use VCRs to tape movies from their TV… rather than purchase them from video stores.

Valenti argued the VCR would ruin the movie industry.

We know that wasn’t true…

The industry thrived in the following 30 years… The S&P 500 Movies & Entertainment index has risen over 800% since 1982.

Today, history is repeating itself.

Wall Street now fears that streaming services like Netflix and Amazon Video will make cinemas obsolete.

At the Daily, we love finding hated and beaten-down industries. Especially when the fear surrounding them is unjustified.

That’s how you find the best values. And value investing is one of the safest ways to beat the market. (Just recently, we told you there were plenty of bargains in the retail sector.)

Today, we’ll show you why the theater industry is the latest bargain for value investors.

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A Rough Summer for Movies

Buying quality companies when they are cheap is a tried and true method that has created some of the world’s richest investors.

And right now, movie companies are cheap…

AMC, Regal, and Cinemark are the nation’s three biggest theater chains. And they’re down an average of 30% this year (see chart below).

Critics justify the decline by citing falling ticket sales.

But despite lower ticket sales, total revenues were down only 4% from last year’s record high. Hardly cause for a 30% sell-off.

Wall Street is taking this one small data point and making crazy predictions. The craziest is that streaming services will doom traditional cinemas.

That’s why investors are dumping their theater stocks.

Yes, more people are streaming movies on Netflix… And fewer people are going to the movies. But to take this and say people will stop going to theaters is pure craziness.

As I noted above, the rise of VHS didn’t stop people from going to the movies.

And even as late as 2009, Wall Street said the $1-per-day Redbox service would put theaters out of business. Wrong again.

We don’t expect streaming services to cause a mass extinction of theaters, either.

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Bad Movies Equal Bad Profits

So, what was the main cause behind the decline in attendance (and stock prices)?

The simple answer is the terrible slate of movies in 2017.

This summer was the worst in 22 years. Box-office sales slumped to 1995 levels.

Did anyone think Baywatch would be a good movie?

I couldn’t tell if it was intended to be a serious action film… or a comedic spoof. (Still not sure…)

The latest King Arthur movie was a huge flop as well. It brought in about $15 million on a $175 million production budget. That’s a $160-million flop.

Other box-office bombs included Transformers: The Last Night, Pirates of the Caribbean: Dead Men Tell No Tales, and the Mummy remake.

According to entertainment trade publication Variety, the “horrific” 2017 summer movie lineup has led to a 6.5% drop in box-office sales from 2016.

But next summer promises to be better. I predict attendance will be much higher.

We’ll see blockbusters such as Avengers: Infinity War, Deadpool 2, and the Star Wars spinoff about Han Solo. These are guaranteed hits.

Here’s the bottom line…

People will go to those movies. And they’ll be willing to pay a premium to see them on the big screen.

Theaters Are a Bargain Right Now

There’s an old Wall Street saying that goes something like this: “If a business will be around in 20 years, now is a good time to invest.”

If you believe movie theaters will still be here in 2037 (as I do), now’s the time to buy them on the cheap.

A good place to start your research is with the three major cinema companies. They have an average price-to-earnings (P/E) ratio of 15.5. That’s a 28% discount to the market.

If the summer 2018 box office will be as big as I expect, these companies will rebound.

Another place to check is our Elite 25 portfolio. Right now, we hold National CineMedia (NCMI). It’s down over 50% this year… despite being a quality company.

NCMI sells onscreen advertisements you see before a movie starts. And it controls over half of this niche market.

Regards,

Nick Rokke, CFA
Analyst, The Palm Beach Daily

ELITE 25 SEPTEMBER UPDATE

Each month, we update our Elite 25 portfolio. We remove stocks that are too expensive and replace them with new stocks that meet our three criteria for elite status.

The Elite 25 crushed it last month…

The portfolio’s average gain was 7.5%. That beat the S&P 500, which only returned 2%.

Wall Street hates a lot of companies in the Elite 25. That’s why they’re trading so cheaply. But once the market realizes their true value, they’ll rip higher.

Sometimes it takes patience for this strategy to play out… And our patience paid off last month.

Aeronautical and retail companies (another hated sector) led the Elite 25. But National CineMedia (NCMI) was the big winner. It’s up 29%.

Weakness in the movie theater sector had dragged down NCMI’s price (see today’s essay). But it looks like a new rally is underway.

Portfolio Changes

We’re removing:

  • Patrick Industries (PATK)
  • Robert Half International (RHI)
  • Tenneco (TEN)

We’re adding:

  • F5 Networks (FFIV)
  • S&P Global (SPGI)
  • Sally Beauty Holdings (SBH)

Click here for the updated Elite 25 list.

[Palm Beach Letter subscribers can read our Elite 25 special report right here.]

IN CASE YOU MISSED IT…

If you missed America’s “pot stock mania,” here’s your second chance to become a marijuana millionaire.

This 58-cent pot stock could soar on October 31, 2017, when Canada votes to legalize marijuana for the entire country.