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Cramer has an annual "Family Affair" episode on his popular Mad Money TV program wherein he re-examines his kid friendly portfolio consisting of stocks that he recommends parents buy for their kids for the long haul. In this year's instalment, Cramer updated this portfolio by removing 3 of the 5 names on the list. Previously, the portfolio included Walt Disney (DIS), McDonald's (MCD), Hasbro (HAS), Apple (AAPL) and Nike (NKE). Citing a variety of reasons, Cramer dropped the last 3 stocks in favor of Whole Foods (WFM), Google (GOOG) and Gap (GPS), respectively. In this article, I will perform a fundamentals based valuation analysis to determine if it makes sense to invest in these companies at current levels. It should be noted that GOOG was excluded from this analysis as I have recently evaluated the stock and presented the results here. The table that follows presents basic information about the remaining 4 companies.

Company Basics

DIS

MCD

WFM

GPS

Market Cap (Billion)

114.9

98.7

19.06

19.3

Debt to Equity Ratio

32%

84%

1%

39%

Stock Performance 5 Yr

88%

64%

278%

-36%

Stock Performance 1 Yr

38%

12%

13%

-4%

Dividend Yield

1.2%

3.1%

0.8%

1.5%

Excluding GOOG, DIS is the largest company on this list with a market capitalization of approximately $115 billion. MCD follows close behind with a market capitalization of just under $100 billion. WFM and GPS are similar sized firms with market capitalization of about $19 billion. MCD has the highest debt to equity ratio in the group while WFM is practically debt free. MCD also provides a comparatively strong yield of 3.1%. GPS is the only firm on the list which reduced in value over the past 1 year and 5 year period. DIS was the best performer last year while WFM was by far the superior investment during the previous 5 years appreciating by 278%.

Growth Rates:

Next, I evaluated the historical growth rates of revenue, income, EPS, book value and the projected growth rates. These are summarized in the table shown below:

Growth Rates

DIS

MCD

WFM

GPS

Revenue

10 Year

5%

5%

14%

0%

5 Year

4%

4%

12%

0%

1 Year

3%

2%

16%

8%

Income

10 Year

16%

14%

16%

1%

5 Year

4%

18%

21%

6%

1 Year

18%

-1%

36%

36%

EPS

10 Year

18%

17%

12%

8%

5 Year

7%

22%

14%

17%

1 Year

24%

2%

30%

49%

Book Value

10 Year

-1%

-2%

4%

-7%

5 Year

-3%

-3%

5%

-9%

1 Year

-5%

-2%

4%

-8%

Growth Projections

Next Year

14%

10%

19%

11%

Next 5 Year

12%

9%

18%

12%

Looking at the historical revenue growth rates, WFM has performed exceedingly well over the past decade explaining the sharp rise in stock price. EPS grew by 30% last year accelerating from the 5 year annualized growth rate of 14%. Barring MCD, the companies experienced strong EPS growth rates last year ranging from 24% to 49%. Going forward, DIS and GPS are expected to grow their earnings at an annual rate of 12% while WFM has a projected long term growth rate of 18%. MCD is predicted to increase its earnings at an annual rate of 9% over the next 5 years.

Margins

After analyzing the growth rates, the next step was the evaluation of gross and operating margins of the 3 firms. The results are presented in the table below.

Margins

Averages

DIS

MCD

WFM

GPS

Gross Margins

10 Year

16%

39%

35%

38%

5 Year

19%

39%

35%

39%

Last Year

21%

39%

36%

39%

TTM

21%

39%

36%

40%

Operating Margins

10 Year

16%

24%

5%

11%

5 Year

18%

30%

5%

12%

Last Year

21%

31%

6%

12%

TTM

21%

31%

7%

13%

As shown in the table above, the four companies on the list have done a remarkable job over the past decade in maintaining their gross and operating margins. DIS increased its margins from an average of 16% over the past decade to trailing twelve margins of 21%. MCD was also strong in this regards reporting a 700 bps increase in operating margins.

Profitability:

To evaluate the profitability of the four companies, ROIC and ROA were selected as the desired metrics. Again, the four companies in the kid friendly portfolio have performed exceedingly well over the past decade and have all increased their ROIC and ROA over the past decade. MCD and GPS have generated especially strong returns during this time period.

Operations

Averages

DIS

MCD

WFM

GPS

ROIC

10 Year

7%

14%

10%

18%

5 Year

8%

18%

8%

21%

Last Year

10%

18%

14%

23%

TTM

10%

19%

15%

24%

ROA

10 Year

6%

12%

8%

12%

5 Year

7%

16%

6%

14%

Last Year

8%

16%

10%

15%

TTM

8%

16%

10%

16%

Valuation:

Having developed a good idea about the fundamentals of the 4 companies, the next step was to perform relative valuation. The multiples used in the analysis were based on historical analysis of individual companies and industry multiples. The table below presents the valuation analysis results.

Valuation

DIS

MCD

WFM

GPS

Next Yr Est

$3.94

$6.24

$1.72

$3.02

EPS Growth Rate

12%

9%

18%

12%

Future EPS (5 Yr)

$6.10

$8.33

$3.20

$4.51

Expected P/E

15

16.8

20

12.6

Price 5 Yrs Out

$91.52

$139.93

$63.95

$56.88

Unlevered Beta

1.09

1.09

1.03

1.34

D/E Ratio

15%

13%

0%

6%

Current Tax Rate

35%

35%

35%

35%

Levered Beta

1.19

1.18

1.03

1.39

Risk Free Rate

2.3%

2.3%

2.3%

2.3%

Risk Premium

6.00%

6.00%

6.00%

7.00%

Size Premium

-0.36%

-0.36%

-0.36%

-0.36%

Cost of Equity

9.1%

9.0%

8.1%

11.6%

Fair Value

$59.33

$91.02

$43.37

$32.78

Current Price

$63.80

$98.42

$51.38

$41.48

% Overvalued

7%

8%

16%

21%

As shown in the table above, all the four companies are overvalued at current levels. The fifth company in the portfolio, GOOG, is also significantly overvalued, making the entire kid friendly portfolio very unfriendly at current levels. The portfolio will only teach how to destroy value (at least in the short term). This is a classic case of 5 great companies that make lousy investment candidates. At current levels, I would recommend selling any existing positions in these 4 companies and waiting for a better buying opportunity in the future. As I expect the broader markets to retreat from current levels, I believe that such an opportunity will be available to patient investors in a few months.

(Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision.)

Source: Cramer's Kid-Friendly Portfolio Is Very Unfriendly For Your Kids