If newspapers are now finding their digital footing faster than observers feared, will Wall Street allow this promising transition to maximize its potential? In 2006, supposedly a disastrous year for newspapers, the average profit margins for the newspaper divisions of publicly traded publishing companies was 17.8 percent, according to the Merrill Lynch media analyst Lauren Rich Fine. That’s well above the average for all industries. Yet newspaper stocks lagged the S&P 500 last year by 21 percent, after another disastrously down year in 2005. Is there something fatally wrong with newspapers that their profit margins conceal? Or is there something amiss with the way Wall Street values newspapers?

As recently as 2002, newspapers and their mostly institutional shareholders were enjoying profit margins in excess of 22 percent, margins that beat even the fabulously lucrative pharmaceutical industry. Newspapers had been local monopolies, and they got used to charging monopoly prices for their most reliable moneymaker, the classifieds. Given Craigslist and Cars.com and Monster.com, those days are never coming back.

Analyst Fine says some newspapers should just level with investors about the need to plow money back into the Internet: “Just put up a sign, work in progress, come back and see us in two years,” she advises. “You’re going to have to judge us differently.” But, as Fine quickly adds, that’s not the way Wall Street works. Further depressions in stock prices invite hostile takeovers and shareholder demands of the sort that killed Knight Ridder. The media analyst John Morton says, “I worry that some publishers will look on their Internet operations as found money, without appreciating that the print is what supports the journalism that attracts the traffic. I worry that they won’t sufficiently invest in people to do it well.”

Even if newspaper publishers do everything right, however, in the Internet age they will have a smaller share of the total advertising pie than they enjoyed in the print era. Newspapers’ share of the $424 billion spent globally last year on advertising, according to ZenithOptimedia, was still a considerable 29.1 percent—but shrinking. The Internet share was just 5.8 percent—but growing. And most Web dollars will not go to newspapers. The Internet competition to monetize traffic is fierce, with most sites designed as pure revenue plays unencumbered by news or civic mission. For example, Barry Diller’s iac/Interactive Corp. is thriving with Web service businesses, such as Match.com, Ask.com, the invitation service Evite, and local city search sites. As newspapers complement their traditional news content with local consumer services and ingenious interactive features, they face competitors who enjoyed earlier market entry and who have high brand awareness. Angie’s List would have been a terrific service to build newspaper Web traffic, except Angie got there first.

Meanwhile, Google, Yahoo, and Microsoft are investing massively in ever more sophisticated search technology. Along with other non-newspaper sites like Wikipedia, Amazon, and eBay, such pure Internet entrepreneurs capture the lion’s share of traffic that can bring in ad money. And none of them has expensive newsrooms to feed. The New York Times and its affiliated papers get visits from 13 million distinct individuals a month. But the nation’s top thirty newspaper Web sites together have under 100 million such monthly visits, while Microsoft, Google, and Yahoo have well over 100 million each, according to Nielsen Net Ratings. The search engines do share some of this ad revenue with newspapers through a variety of ad partnership models—Google wrote checks of $780 million to its ad “content partners” in the last quarter of 2006—but the other large Web entrepreneurs are pure rivals.

On the other hand, newspaper companies themselves are increasingly investing in the purchase of Web income-generators, such as the Times’s 2005 acquisition of About.com, and Dow Jones’s decision to sell six of its fifteen Ottaway dailies in late 2006 and use the proceeds to purchase Factiva.com, a subscription-only search company. In 2000, the Tribune Company and Knight Ridder bought CareerBuilder.com, later joined by Gannett; it’s now the most popular online recruiting site. Here again, independent newspapers with shallower pockets do not have this capacity. They have to invent their own Internet services, and hope that if they build the traffic, ad revenue will come. And, as attractive as it is for publishers to use Web properties to subsidize lower-return newsrooms, a purely financial calculus by a Wall Street profit-maximizer would say: spin off or shut down the lower-yield newspaper and keep investing in the lucrative Web property. All of which shows that newspapers may well require owners with values that go beyond the marketplace.

Robert Kuttner is co-editor of The American Prospect.