Starbucks (SBUX), our first pick for the Accumulator Portfolio, is up 5% since the position was initiated. While the valuation continues to look a little stretched, the caffeinated stock continues to power higher. As a reminder, the Accumulator Portfolio will be constructed from the stock of companies with sustainable competitive advantages and monopoly-like business models.
My next pick is The Walt Disney Company (DIS). If I'm being honest, I have mostly written Disney off as a smart investment until recently. The acquisitions of Pixar and Marvel had me thinking twice, but it was 2012's acquisition of Lucasfilm that sealed the deal. The depth and popularity of the films in the pipeline is simply staggering. It's true that an investor has to look no further than the colossal failure of "John Carter" to understand that Hollywood is risky business, but Disney's growing and diversified collection of media assets has made me a believer.
A strong and rising earnings trend often indicates a business benefiting from a consumer monopoly and profit-minded management.
Disney Earnings per Share
Like Starbucks, Disney's dependence on an ailing consumer caused its earnings to suffer during the 2008 financial crisis. For some perspective, I researched historical ticket prices at Disney's theme parks, which happen to be my least favorite part of the business. In 1981, a ticket to Disneyland would set you back $10.75 (the cost of a movie matinee in 2013) and has increased nearly 900% since then. Impressive pricing power. The value of the Disney theme park experience has far outpaced inflation.
Disney carries a long-term debt load of $10.7 billion on a shareholder equity base of $40 billion (debt to equity ratio is .3). Based on annual net income of $6.5 billion, Disney could pay off its debt in less than two years.
Return on Equity
Companies that consistently deliver high returns on shareholder equity are true wealth creators. Average businesses typically offer a 12% return on equity while great businesses return over 15%.
Disney's Return on Equity
Disney's average return on equity over a 10 year period is 11.3%. While this is on the low side of what I like to see, I'm encouraged by the trend. Rising return on equity suggests a management team that is learning over time how to extract the most value from the business.
Whether it's via share buybacks or new investment in the core business, I want to own companies that are free to reinvest retained earnings at high rates of return. What I don't want to see is high research and development costs or capital expenditures in the form of plant and equipment replacement. In Disney's case, there are no R&D costs. Capital expenditures were $2.8 billion in the trailing twelve months, or a reasonable 43% of net earnings. Free cash flow is positive.
Disney owns a sprawling empire of properties so cap ex spending is inevitable. Most recently, spending has been focused on the Disney Fantasy cruise ship, expansion of Disney California Adventure and the construction of Disney's Art of Animation Resort. Given the trend of rising returns on equity, I expect these investments to enhance shareholder returns in the future.
Current yield on Disney shares is 1.18%. The dividend has doubled since 2009 and the payout ratio is still very low at 23%. This is a company in the very early stages of growing its dividend substantially.
Disney's current P/E is 19.4. Looking at its 5-year average P/E of 15.2, Disney is moderately overvalued based on its historic valuation. However, considering average EPS growth of 19.8 annually over the past 3 years, Disney looks attractive. While some investors believe the stock has run too far too fast, many popular dividend growth names like Johnson & Johnson (JNJ) and Kimberly-Clark (KMB) are only offering single-digit growth rates yet pricing above 20 times earnings. Disney is a buy here.