COLUMN: It always is entertaining to look at Warner Bros.' financial results. Throughout its various permutations and incarnations it has remained a diversified entertainment conglomerate with interests in both music and films. It always has been subject to the financial reporting requirements of the U.S. Securities & Exchange Commission, which has tended to make its corporate operating results internally consistent and comparable from year-to-year. Although it spun off music in 2004 there is no evidence the Warner Music Group would be run much differently than it would be if it still were an operating division of the Warner Bros. conglomerate.

This confluence of circumstances raises an interesting hypothetical question. Which would you rather own: the Music Group; the Studio; or maybe neither? Of course the economics of film are completely different from those of music. Among other factors the cost to make a movie is considerably more than the cost to make a record. The way you recover your investment in these assets is different, as is their accounting treatment. An important variable is the extent to which a division contributes to the conglomerate's over-all operating results. Notwithstanding these and other considerations, I contrived to imagine a hypothetical world in which cash-flow, return on investment and level of corporate involvement weren't the critical issues. Rather I decided to focus solely on return on sales (“ROS”), which is the ultimate litmus test of the profitability of any business. It is calculated by dividing each division's pre-tax operating income by its pre-tax operating revenue. “Pre-tax” in this context (typically) means before the assessment of corporate allocations, interest charges, depreciation and amortization and Federal and state income taxes. For these reasons it's the best indicator of how the fundamentals of the business itself actually are doing.

I extracted these numbers from the Warner Bros. annual reports and other financial information for each year from 1968 to 2008 – 40 years of operating history. Accountants have an annoying habit of “restating” each operating division's financial results on a “what if” basis. That is, if a division acquires a new company, or divests itself of one, the accountants typically will go back and restate pre-tax operating income and pre-tax operating revenue to pretend the new one always was (or wasn't) there. For this reason I used the annual report for each year rather than relying on summaries of previous years' results. There are a variety of other ways in which accountants manipulate operating results, such as taking or releasing reserves, accelerating depreciation or amortization of assets, writing off ones they don't like, holding back or accelerating receivables, and similar techniques. If this sounds somewhat fishy to you, I agree, particularly in these tough economic times when there is widespread evidence of corporate malfeasance and business scandals. This being so, a company's publicly-reported financial data is the best (and only) source of information that's out there. If it's any comfort, to the extent that accountants misrepresent corporate results, they tend to do so consistently.

With these caveats the Music Group's ROS ranged from a high of 16.8% in 1968 to a low of minus 34.3% in 2003. The Film Group's ROS ranged from a high of 20.3% in 1978 to a low of 2.4% in 1969. It's not fair to pick out single years in isolation. A better strategy for evaluating profitability is to clump years together, for example in five-year periods, or in correlation with the tenure of a particular management regime. I'm posting the raw data at www.deconstructingpopculture.com if you can figure out a way to do this meaningfully. The most interesting result is that average Music ROS over the period was 6.1% and average Studio ROS was 10.1%. Which means that all other factors being equal you would have made more money by investing in the Studio than the Music Group.

I thought it would be interesting to compare these results with the return on 1-year U.S. Treasury bills. Treasury bills are indebtedness issued by the government. They're like a loan people make to the government in consideration for the government's promise to pay them back on maturity (when the loan becomes due). You buy them at a discount; for example, you pay $95 now for a Treasury bill that pays $100 on maturity, resulting in an implicit interest rate. You also can buy and sell them in the secondary market, which gets more complicated. Their interest rate is fixed so their value goes up if interest rates in general go down, and vice versa. There are a variety of Treasury bills, notes and bonds, depending on their maturity. Although there have been notable exceptions, generally speaking longer-term bonds and notes carry a higher rate of interest than shorter-term bills.

Trying to keep all of these factors in mind I decided to pick 1-year T-bills because that's the length of a company's fiscal year, so it sort of matches. The investment choice I was attempting to pose is: should one invest in a 1-year T-bill; or the Music Group for a year; or the Studio for a year. This resulted in the most comparable outcome. I got statistics for interest rates from the Federal Reserve's web-site (the Federal Reserve is the governmental agency charged with controlling things like interest rates). Each year's average interest rate on 1-year T-bills appears together with Music Group ROS and Studio ROS. The average rate for 1-year T-bills over the entire period is 6.5%. This is more than the Music Group but less than the Studio.

This is a pretty interesting result. Using a bunch of calculations I won't bore you with here it's possible to show the T-bill is a far less risky investment than either the Music Group or the Studio. In fact U.S. government debt obligations are the least risky investment you possibly can hold. They're even better than cash, because cash depreciates depending on inflation, whereas government indebtedness at least pays interest. And the government isn't about to default. So rather than enduring the hassle of running the Music Group (temperamental artists, capricious consumer demand, impact of new technologies) it would be more profitable simply to sit there with your hands neatly folded and clip a risk-free coupon sent to you by the government.

But probably not as much fun.