In Part 1 of this series (a quick series, as this is the last part!) I outlined two facets that Disney (NYSE:DIS) excels in and that will contribute directly to the valuation of the stock. First, the ecosystem is exemplary. The way I translate the ecosystem quantitatively to the value of the stock is by awarding Disney a higher P/E than it would garner without the fantastic ecosystem that it enjoys. This will be discussed below. Second, Disney has excellent prospects for truly long-term growth. This will be reflected in the discounted earnings model and in the dividend discount model, also discussed below.
Before I get to the valuation models, I will show some other metrics that I consider key to valuing any stock.
Return on Equity
Disney's ROE and ROA are trending up very nicely since the Great Recession (the shaded area), and are actually at 10-year highs. These are strong indicators that the company is managing its money well.
Profit margins are always key to keep an eye on, and Disney does not disappoint here either. Again, the trend is up, and again, we see 10-year highs.
Net Common Payout Yield
The net common payout yield is the dividend yield plus the net buyback yield. For example, if a company with a market cap of $100 million repurchases $10 million worth of stock in the last twelve months, issues no new stock, and has a dividend yield of 3%, then the net common payout yield would be 13%.
Shucks, no 10-year high here. But it is quite good, except for the dip in late 2009/early 2010. A yield of 8% or more I consider to be excellent, and a yield of 10% or more is exceptional (and rare to keep up for long). We can see that Disney has been steady around 4-5% for the last couple of years, which is good. DIS pays a fairly low dividend, and while it buys back shares, it is not particularly aggressive in doing so, therefore, it has room to grow the payout yield in the future.
The average estimate, as shown on Yahoo Finance, for Disney's next five years' EPS growth is 16.03%. Using that figure for five years, followed by 11% for the next 20 years, and plugging in a discount rate of 10% gives a Fair Value number of $117.10.
The Fair Value calculation is only as accurate as its inputs, so it is important to weigh the odds of DIS living up to the 16.03% five-year growth that analysts are expecting. Looking backwards at the earnings growth gives some data to compare:
- Last five years: 19.0% average earnings growth per year
- Last ten years: 12.1% average earnings growth per year
The estimate of 16.03% looks very reasonable considering Disney's past. The figure could even be conservative, since the margins of the company are rising recently and DIS has beaten analyst estimates in the last two quarters (Source: zacks.com).
Much of the Fair Value that I calculate above comes from the 11% growth that I have modeled for 20 years after the "high growth" five-year period. For most large companies, this part of the calculation uses smaller growth assumptions, and I run it for 10-15 years. However, as I wrote in Part 1 of this series, I believe it is appropriate to model stronger growth for Disney for a longer period of time than for most other large-cap companies.
In fact, I think I am being conservative with the numbers. 11% is a little under what DIS has accomplished over the last 10 years -- a span that includes the Great Recession. Furthermore, I think the 20-year assumption is conservative. I think Disney could show strong growth well past that time frame.
Dividend Discount Model (DDM) Valuation
The DDM method is a variation of the DCF method. The DDM was the brainchild of John Burr Williams in the 1930s, who thought that a stock's worth should be calculated as the present value of all the dividends to ever be paid on it.
Disney's 10-year dividend history:
While Disney did not pay out much in dividends from 2004 through 2010, it has certainly ramped up the payments since then. Here are the last five years of dividend history (note that DIS pays an annual dividend):
- 2009: $0.35
- 2010: $0.40
- 2011: $0.60
- 2012: $0.75
- 2013: $0.86
The current yield for DIS is 1.04%, and the payout ratio is 22.1%. From 2009 to 2013, the company grew the dividend at an average of a little over 25% annually.
While the increases have been impressive lately, Disney probably won't keep that up for long. For the dividend analysis, I will assume 2/3rd of the EPS growth that I used in the discounted earnings analysis above. In other words, 10.69% dividend growth for five years, followed by 7.33% growth for 20 years. I also project an eventual payout ratio of 70% (reflecting a very mature, no-growth company eventually).
Using the above (conservative) inputs results in a Fair Value of $117.43.
Disney is at a 10-year high for its forward P/E. This is a concern, of course, although it is not a surprise. The market as a whole is up, and Disney, in particular, is firing on all cylinders right now.
In Part 1 of this article series, I promised that I would quantify Disney's fabulous ecosystem by allowing it a higher P/E than I would if it did not possess the ecosystem that it does. Because Disney can monetize a media franchise like, perhaps, no other company in the world can, a higher multiple is deserved. Consider the Star Wars franchise -- what can Disney do with it? In my opinion, more than any other company can. Thanks to that powerful ecosystem, I expect to see new Star Wars games that make more money than the previous ones (many in the past were considered flops), I expect to see Star Wars themes at the parks, and I expect to see new Star Wars TV series.
If another media company had bought the Star Wars franchise, it may have done well for that company, but could that company do as much as Disney will? When Disney buys or creates a franchise, it can simply make more money from it than a company with a weaker ecosystem can.
For now, I will be conservative and assign a Fair Value for Disney that corresponds to a forward P/E of 18. While I like the stock at 20x forward P/E, the chart suggests that, in the near-term at least, investors may balk at the rising P/E. At my forward P/E model number of 18, we get a Fair Value price of $74.76.
Overall Fair Value
No pricing model is perfect, and each is only as good as its inputs. I try to be conservative for each model that I produce, and if strong numbers are a result, then I am confident in the stock. To recap the three valuation methods that I have used:
- Discounted earnings: Fair Value of $117.10
- Discounted dividends: Fair Value of $117.43
- Forward P/E: $74.76
The average of the three gives an overall Fair Value of $103.10, representing an upside of 24.5%.
While many writers have looked at metrics such as the forward P/E and claimed that DIS is overpriced, that is but one piece of the puzzle. In addition to my ecosystem argument above, it could additionally be argued that the stock deserves a higher multiple due to:
- Handily beating analyst's estimates by over 14% in the last two quarters.
- Steadily improving margins, ROE, and ROA numbers.
- Increasing its dividend by an average of 25% annually.
I am a buyer of DIS at the current price. I can see why some people are skittish about the near term, but Disney truly is firing on all cylinders, and frankly, deserves a higher P/E. Let's say that the analysts are spot-on and DIS grows EPS by 16% for the next five years. Starting at a current TTM number of $3.89 per share, in 2019, the TTM EPS will be $8.17 per share. That would be a stock gain of perhaps 80%-110% in five years (which actually assumes some P/E contraction), exceeding what can reasonably be expected in the broader market. Strong growth deserves high valuation.
Additional Disclosure: Long DIS since 2004.
Disclosure: The author is long DIS. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.