Microsoft Or Disney - Which To Buy

| About: The Walt (DIS)

One of the advantages of having limited investment money is that it forces you to be selective. I have two pots of investments funds, one at work, which is invested in three index funds and a brokerage account where I currently own six stocks. Five of the six stocks I own are large positions. I believe it is better to have a few large positions I have a lot of confidence in than a bunch of small positions I have varying degrees of confidence in. Therefore, what I try to do is find a company I have a lot of confidence in and build a large position. When I finish building that position, I look for another company to build a position in. Over the last year I have been in and out of a number stocks as I cannot seem to find that company I have confidence in, or outside factors, like rising interest rates, change my view of the company.

Which brings me to my current conundrum. After watching a Microsoft (NASDAQ:MSFT) Analyst Presentation, I became convinced the future for MSFT was promising. The stock was cheap, various components of the business were growing rapidly and it paid a healthy dividend of 3%. I was convinced enough that I started a position in October at $32.97. I currently own what I would consider 20% of a full position. Over the last 6-weeks the stock has had a nice little pop, currently selling at $38.11.

Although I still have confidence in MSFT, I recently became enamored with Disney (NYSE:DIS). I am probably late to this thought, but I realized that people want information and entertainment everywhere. Whether they are in their living rooms, on their computers, on the go with their cell phones, or using their notebook/tablet, they want information and they want entertainment. The desire for constant information and entertainment is creating demand for content and there is no better content company than Disney. The trend for information and entertainment everywhere is only going to grow and I believe DIS will grow with it.

Two stocks I like, but limited funds for investment. I realize I could start a position in DIS and then slowly grow both positions, but my preference is to examine both companies and make a concentrated bet on the company I feel will be more rewarding. So I took a look at both companies and this is what I found.

The Business

Microsoft is a leading software, services and device company. MSFT's Windows operating system and Office productivity software are dominant brands and huge revenue producers for the company. MSFT is a dominant force in enterprise software and is growing rapidly in cloud services. This is a quote from MSFT's recent 1st quarter 2014 earnings conference call "Moving on to the enterprise, where demand for our solutions continues to be strong. Earlier this month, we announced our fall wave of enterprise products and services, which touches nearly every aspect of IT. We are seeing solid growth. We are outperforming our competitors and we are taking share in areas like virtualization and the data platform." The PC business has been slowing which has been a drag on recent earnings reports. MSFT is trying to grow their mobile business, but are still well behind other competitors.

Disney is a media company with businesses in film, television, internet, theme parks, cruise ships, and consumer products. Disney films this year have grossed over 4-billion dollars. When you think of media brands, Disney has more than its share, ESPN, Pixar, Marvel, are just a few of the dominant brands Disney owns. Disney is unrivaled in its ability to take a brand or character and derive multiple revenue streams from it. For example, after buying Marvel, Disney made several films with Marvel characters, sold toys of the characters, is now building an Iron Man theme park attraction and has created television shows from Marvel characters.


Below is a chart that takes a look at the last five years of earnings growth from each company.


Year EPS
2009 $1.62
2010 $2.10
2011 $2.69
2012 $2.00
2013 $2.58


Year EPS
2009 $1.76
2010 $2.03
2011 $2.52
2012 $3.13
2013 $3.38

Disney has been the more consistent earnings grower, almost doubling earnings since 2009. However, that is looking backward, let's see what the earnings forecast are.

Earnings Forecast

Using Yahoo! Finance, the average projected earnings for Microsoft in 2014 is $2.91. The 24 analysts forecast a 5-year annual earnings growth of 7.18%.

For Disney, the average annual projected earnings in 2014 is $4.50, where 26 analysts forecast a 5-year annual earnings growth of 14.56%.

On the earnings front, Disney has been the more consistent earnings grower and is forecast to grow earnings faster in the future.


Disney is forecast to grow earnings faster in the future, but I also see that DIS is selling at a P/E of 21, while MSFT is selling at a P/E of 14. So I did some math to see what the share price growth will look like in the future.

As I write this, MSFT sells for $38.11. MSFT reported 2013 earnings of $2.58, if MSFT's earnings grow as expected (7.18% a year) the 5-year stock price growth would look like this, assuming it maintains its current P/E.

Year % EPS Growth EPS P/E Stock Price
2013 $2.58 14.8 $38.11
2014 7.18% $2.76 14.8 $40.91
2015 7.18% $2.96 14.8 $43.84
2016 7.18% $3.17 14.8


2017 7.18% $3.40 14.8 $50.35
2018 7.18% $3.64 14.8 $53.93

Disney is trading today at $70.61, 21 times its 2013 reported earnings of $3.38. If DIS grows its earnings at the expected 14.56% a year, the 5-year stock price growth would look like this, assuming DIS maintains its current P/E.

Year % EPS Growth EPS P/E Stock Price
2013 $3.38 21 $70.98
2014 14.56% $3.87 21 $81.31
2015 14.56% $4.44 21 $93.15
2016 14.56% $5.08 21 $106.71
2017 14.56% $5.82 21 $122.25
2018 14.56% $6.67 21 $140.05

Now I fully realize the chances of things turning out as they are shown here are about zero. Many things can affect earnings and P/Es can rise or decline based on current expectations. However, this exercise shows me that Disney's higher expected earnings growth, double of MSFT's, leads to much faster stock price growth. Disney's stock price practically doubles, while MSFT's stock price grows approximately 41.5%. Based on those assumptions, I believe Disney, despite the higher P/E, is the better value at today's prices.


I am a dividend growth investor and it did not take long for me to see that DIS does not meet my minimal standard of a 2% dividend. Although I know MSFT will have the advantage in this category, let's break it down anyway.

Using David Fish's excellent DRIP Investing Resource Center we see MSFT is a Dividend Contender having raised its dividend 11 straight years and is currently yielding 3.0%. It recently raised its dividend 22.1% and has raised the dividend an average of 15.1% over the last 5 years. With a payout ratio of approximately 34% and with strong cash flow, MSFT will be able to raise its dividend for years to come.

MSFT currently pays a dividend of $1.15, assuming MSFT raises the dividend 15% a year for the next five years, the dividend growth would look like this.

Year Dividend amount DIV Growth % $ raise
2013 $1.15 15% $0.173
2014 $1.323 15% $0.198
2015 $1.521 15% $0.228
2016 $1.749 15% $0.262
2017 $2.011 15% $0.302
2018 $2.313 15% $0.347

Disney is hard to classify when it comes to dividends. It pays its dividend annually, not quarterly, and has an uneven history when it comes to dividend increases. Disney froze the dividend in the 2000 to 2003 period and the 2007 to 2009 period. Recently, DIS has been aggressively raising its dividend, implementing a 25% hike to $0.75 last year, which is on top of a 50% hike the preceding year. The payout ratio is 22%, so it appears they have room to raise the dividend going forward. However, with Disney's uneven dividend history, I am not comfortable forecasting any average growth rate. So for now, I will assume the $0.75 dividend is the going rate until next year.

When it comes to dividends, MSFT is the clear winner.


I prefer to own companies that have some level of a moat. In my opinion, both MSFT and DIS have a moat. Think of productivity software and Microsoft Office will likely be what you think of, think of operating systems and Windows would be the likely top choice. But, MSFT also dominates in the enterprise. Here are just a few statistics from the corporate world. Azure is used by 50% of the Fortune 500 and revenues are growing 200%. Two out of three Information Workers use SharePoint. Approximately 85% of the Fortune 500 use Yammer, 90 out of the Fortune 100 use Lync and SQL Server is the most widely deployed Database in the world and is growing share.

I believe the above statistics show MSFT has some level of moat

If you were to ask someone to name a company involved in children's entertainment, I would bet the vast majority would say Disney. Ask a sports fan their favorite sports channel, the answer will be ESPN. Ask someone what theme park they want to visit, Disney World would be the top answer. Ask what their favorite cartoon character is, Mickey Mouse will be in there somewhere.

In the moat category, both have enough of a moat that their businesses are not going to disappear anytime soon.

Do The Math

The question for any investor should be, in 5-years time where will my money earn the best return, so I used the figure of $10,000 and calculated what the better return is in 5 years.

With $10,000 I could buy 141 shares of Disney at $70.61. If in 5 years earnings grow as projected and the stock price grows as calculated in the previous chart, those 141 shares would be worth $19,747 (141 x $140.05). Add in the 1% dividend DIS pays and over 5-years time I essentially have a double.

If I invest $10,000 in MSFT, I will buy 262 shares. If in 5 years earnings grow as projected and the stock price grows as calculated in the previous chart, those 262 shares would be worth $14,129 (262 x $53.93). Add in MSFT's 3% dividend and I would have a gain of a little over 50%. What I cannot quantify, but am aware of, is the effect reinvested dividends would have. Assuming I reinvest the dividends paid back into MSFT, that would in turn buy more shares, which would provide a greater yield, which buys more shares, etc. That would add to MSFT's return, but not likely enough to overcome Disney's rapidly growing earnings and share price.

I will repeat what I said before, I know the likelihood of this occurring as calculated is zero. However, it does show me there is a large enough difference in the projected growth that even with a little better performance by MSFT or poorer performance by DIS, DIS is the better investment.

Adding weight to the DIS earnings growth story is the past 5-year earnings chart showed me that DIS has been consistently growing its earnings, while MSFT's earnings have been more bumpy.


When evaluating a company, there may be some outside influences that are hard to quantify. That is the case currently with MSFT. The investment community is hoping that Alan Mulally is named the new CEO. Every time a news story breaks that the list of candidates has been narrowed and Alan Mulally's name is still on the list, the stock goes up. In my judgment, the current MSFT price is slightly inflated due to the expectation that Mr. Mulally will be named CEO. If someone else is named, I am fairly confident the stock price will drop. If the price drops, MSFT at a price around $30.00 becomes very competitive with DIS, especially factoring in the larger dividend.


This is difficult for me to decide because I believe in being disciplined and buying a stock yielding 1% goes against my rule that any stock I buy must have a minimum 2% yield and a history of growing the dividend. Disney does not have either one of those. In addition, one of my investment goals is to grow my income and DIS will provide little help with that.

Buying DIS would also go against my belief that over the long term, dividend paying companies will outperform companies that do not pay a dividend or pay a minimal dividend. I have mentioned many times that Jeremy Siegel's book "The Future for Investors" has had the most influence on me as an investor. Siegel clearly showed that over time dividends are the most important factor in investing success. However, Seeking Alpha contributor Chuck Carnevale, an author I respect, recently wrote this article, which stated for maximum total return, growth stocks are best. That article made me think that perhaps adding some growth to my portfolio would not be a bad thing.

One thing I am confident of is that at $38.00, MSFT is overpriced, at least in the short term. Thus at $38.00, I will not add any more money to MSFT.

Disney is currently selling for a fair, not a bargain price. DIS started the year selling for approximately $52.00 and is now over $70.00, about a 33% gain for the year. I would like to buy DIS in the $65.00 range and will wait for a fall back to that price to initiate a position. I am a little uneasy owning a stock that pays a small dividend, especially one that only pays once a year, so I want to own it at a price where capital gains are highly likely.

The market has had a great year so I don't feel compelled to rush money into either investment. I believe both companies will do well in the future, to ensure I create the best possibility for future gain with a margin of safety, I will wait for a better price on both.

Disclosure: I am long MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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