I've Found a Secret Way to Play These Stocks...

Ryan Fuhrmann's picture

Thursday, January 20, 2011 - 9:00am

by Ryan Fuhrmann

In my recent article, "5 Stocks That Could Win in the Digital Age," I examined five large media companies that were poised to not only survive the onslaught of the Internet and the Digital Age, but thrive. A couple of my picks in that article have more than one class of stock, which may be a little confusing at first. But after a bit of further research, it could prove to be a profitable opportunity.

I'll explain...

A number of companies listed on the stock market have more than one type of common stock. In most cases, the different share classes have different voting rights. Most of the time, this is pretty straightforward: one class usually has voting rights while the other doesn't. In other cases, the issue that usually arises is that these different classes of stocks start trading quite differently.

For those of us that value a company based off its cash flow, there shouldn't be any difference, as each share has an equal claim on a company's cash flow. In reality, there can be value to having voting rights. This usually doesn't mean much to individual investors, but it can be extremely important to someone wanting to gain control of a company.

Take Sumner Redstone for instance, who is primarily responsible for building Viacom (NYSE: VIA) (NYSE: VIA-B) into one of the largest media firms in the world. Back in 2008 the company created two classes of stock. A reason cited was to issue non-voting "B" shares for acquisitions, so as to not dilute Redstone and his family's control of the company he built.

Interestingly, the prices of the "A" and "B" shares used to trade pretty closely together. But they have widened over time: the "A" shares with the voting rights trade at nearly a 15% premium to the non-voting "B" shares. This seems like a pretty wide disparity.

Below is an overview of three other companies with different share classes.

Redstone also happens to control the CBS Corp. "A" shares, which also have voting rights. CBS (NYSE: CBS) (NYSE: CBS-B) was spun off by Viacom at the same time the two classes of Viacom stock were created. As you can see, the CBS shares trade very closely together.

Media rival Discovery Communications (Nasdaq: DISCA) (Nasdaq: DISCD) (Nasdaq: DISCK) has two classes of stock that have voting rights (the "A" and "B" shares) and one that does not ("K" shares). The voting shares trade at an even bigger premium to the non-voting "K" shares, as compared with Viacom.

Finally, Brown-Forman (NYSE: BF-A) (NYSE: BF-B), a spirits company that owns the Jack Daniels whiskey brand, has two classes of stock that trade tightly together.

As you might have guessed, quite a few market participants have done some studies on how different share classes from the same firm tend to trade in relation to each other over time. The million dollar question is whether there is an appropriate premium to be paid for voting rights. One academic study I found suggested that voting shares should garner an average premium of 5% in the U.S. market.

Investors can look to exploit the differences in stock prices between voting and non-voting stock. Again, a corporate raider or other entity looking to influence or take control of a company with multiple share classes will only be interested in the ones that have voting powers.

But for the rest of us, it doesn't make as much of a difference. Sure, when different classes trade very close to each other, it makes sense to buy the ones with voting rights. I used this philosophy when I invested in Brown-Forman and bought the "A" shares when the premium over the "B" shares was very small.

Action to Take ---> Returning to the theory that any class of stock has an equal claim to a company's cash flow, I would argue that it is worth investing in the non-voting shares of a company when the difference in share classes becomes large. Looking at the stocks above, I think the Viacom "B" shares and Discovery "K" shares look pretty compelling at current levels. [For more analysis on these companies, go here.]

Of course, a key part of the equation is to also look at a company's business fundamentals. Viacom trades at a very reasonable valuation: the "B" shares only trade a 12.6 times earnings expectations for this year. The Discovery "K" shares are a bit pricier at a forward price to earnings of 18.9, though they're still cheaper than their "A" and "B" share counterparts, but I like the stock's growth prospects going forward. [Related: "Why Oprah could send Discovery's Stock Soaring..."]

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Ryan Fuhrmann does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.