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Don’t be fooled by the histrionics and high-flying stunts. World Wrestling Entertainment (NYSE:WWE) is an excellent business. With a return on invested capital over 22%, it is one of the most profitable companies in the United States. Though revenues fell in the last reported fiscal year, the company’s profits rose as it was able to cut expenses and boost margins. Few businesses are flexible and scalable enough to boost profit margins when revenues decline. And seeing how cheap the stock is leads us to believe that few investors have adequate appreciation for the strong economics of the WWE business.

Specifically, the current stock price (around $13) implies that investors believe WWE’s profits will never grow from current levels. There is no future profit growth in the stock price even though the company generated $87mm in free cash flow (10% of its enterprise value) and $36mm in economic earnings during its last reported fiscal year. WWE’s strong economic (as distinct from accounting) cash flows and its cheap valuation land the stock on our list of most attractive stocks for February.

We also believe that WWE’s business model and strategy is under-appreciated because of the somewhat silly product it sells. Investors do not seem to recognize the scalability of the WWE product. WWE can tape one match and sell it into as many markets as it has viewers. International growth prospects for the company are, therefore, strong.

The company has plenty of cash to fund international growth with excess cash at $207mm (over 20% of market cap). At the same time, the company enjoys relatively low and fixed costs of goods sold as the salary paid to its wrestlers is roughly the same no matter how many viewers see a match. There is little to no requirement for research and development. The biggest expense is advertising, which is significant at about 27% of revenues, but it is also very controllable and can be cut when times are tight to preserve profit margins. WWE fans tend to be very loyal as anyone who has ever attended any of WWE’s live events can attest; so advertising is mostly focused on getting new customers.

WWE also enjoys a fairly low cost of talent. Most of its wrestlers are ex-athletes whose professional careers never developed or have ended. For these ‘actors’, the WWE offers the next best alternative to being a professional athlete. Other professional alternatives are not nearly as attractive. In addition, WWE has rarely, if ever, been beholden to any one wrestler in a way that professional sports teams can be beholden and forced to pay a particular athlete. There is a large and steady pipeline of ‘actors’ willing to take the WWE stage. Anytime a particular ‘actor’ gets expensive, WWE can replace him or her with a new, cheaper version.

WWE gets our “very attractive” stock rating because the business is throwing off a lot of cash, showing strong growth in profits while its valuation implies economic earnings will never grow from current levels when we see strong upside potential.

WWE fits the risk/reward pro­file of a great stock to buy.

For details on what causes the dif­fer­ence between eco­nomic ver­sus account­ing prof­its during the last five fiscal years, see Appen­dix 3 on page 10 of our report on WWE. See Appen­dix 4 to learn how WWE increased net operating profit after tax (NOPAT) and its NOPAT mar­gin from 9.5% to 10.8%. WWE’s ROIC (detailed in Appendix 7) rose from 18.8% to 22.2%. WWE’s invested cap­i­tal grew more slowly than revenues; so invested cap­i­tal turns rose from 1.98x to 2.09x during the last reported fiscal year.



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: World Wrestling Entertainment: Solid Business Behind the Histrionics