As you may have heard, The Lion King 3-D took home last weekend’s box office crown pulling in roughly $30 million, while they were only expected to make one-third to one-half that. Now in the movie game $30 million may not seem like a lot, but when it costs “single digits” to make, its not a bad day’s work. An issue for Disney (DIS) investors, however, is the fact that their stock was worth more when The Lion King came out in 1994 than it is now (there was a 3-for-1 split in 1998).
But looking at Disney’s current share price and revenue streams, it appears to be grossly undervalued. Undervalued stocks make for great investments in a multitude of situations. Income investors are advised to make large purchases of big dividend paying stocks only when prices are low, so as to capitalize on capital gains and establish a low cost basis. In that vein, short- to mid-term investors should also be drawn to stocks like this to pick up near certain gains.
Keeping this in mind, I am going to present two stocks that have taken a beating because of the market volatility and economic instability of America. I should first disclose that I do own stakes in each of these companies, but I am not writing about them in an effort to push their prices up. I have zero intention in selling either anytime soon, and each were purchased in my name when I was very young—actually probably just around the time the Lion King was released the first time around. However, because I do own each, I have a bit of an understanding as to how and why their price moves.
Disney – Disney peaked this year just over $44 and is now trading for $32.50, because of some poor guidance, despite the fact that their quarterly results were impressive. A 26% drop is completely unwarranted for a company that is nearly certain to turn things around and continue to generate increasing revenue in the long run.
Disney operates five not wholly distinct segments: television media, resort parks and hotels, studio entertainment, consumer products, and interactive media. I say not distinct because they all feed into each other. Disney has a new initiative to only produce movies that will likely turn into franchises. We’ll look at Cars as a case study. The movie killed it at the box office (both times), but more importantly, the franchise could spin-off television shows, children’s video games, theme park rides, and toys. Their acquisition of Marvel will also start paying significant returns now that their distribution holding period has ended.
Fundamentally, Disney is expected to return to pre-recession levels in 2011. The recession was especially hard on them for two reasons. First, advertising revenue dropped significantly. 67% of Disney’s income comes from television, mainly ESPN and ABC, so this was a blow. Secondly, everyone expected theme park returns to suffer -- remember when the newspapers were pushing "staycations"? Well our economy has still not fully recovered from this, and many would argue that we are actually worse off. The parks represent 17% of Disney’s income, so it will be important for the other segments, like movies, to step it up. Pirates of the Caribbean and Cars 2 each did very well, and there are some big names coming up, including the Muppets movie (2011), The Avengers (2012), and Iron Man 3 (2013).
Above is a three-year graph which tells a totally different story than the one-year. The objective of the first was to show the recent drop, and the objective of this is to show that things are still okay. There seems to be some support at the $30 level, and barring some major economic news, I don’t think we will see shares drop much further. Also, what you cannot see on this graph is the relative drop in P/E as a percentage gauged against price. Percentage-wise P/E has dropped further than price, emphasizing that the price is relatively cheap right now. Most of the price targets still have Disney over $40, so it's a steal at $32.50.
Dover Corp (DOV) – Unlike Disney, nearly no one has heard of Dover Corp, aside from those of you who troll the list of annually increasing dividends. Dover is third on that list, and has been increasing its dividend annually for 54 years. Needless to say, that is incredibly impressive. Dover is a large industrial conglomerate, with over 40 companies, several of which have their own lists of subsidiaries. Some of the products of these companies include: microwaves, refrigerators, beverage can producers, diamond drill-hole tools, ATMs, fuel pumps, hydraulic cylinders, and parts for garbage trucks. My point is that they are extremely diversified, and under a strong management team who knows when to pull the trigger on subsidiaries.
But as the chart above shows, it has taken a hit to the tune of (oddly, the same amount as Disney) 26%. This came as a result of an awesome earnings report that offered poor guidance. Using the term poor is misleading; Dover is still expected to have good EPS reports (higher than past years), but the expected growth has slowed.
The fact of the matter is that the growth is still there and is expected to return with some pace in the coming years -- but you can buy it right now for a huge discount. Additionally, this discount has brought Dover’s dividend, which was increased this quarter, to a yield of 2.4%. Now, I know that most DRIP investors would be looking for 3% or better, but again, this company has been increasing its dividend every year since 1957. If you were to pick Dover up at the right price, you could probably set it and forget, like in an IRA, perhaps.
Above is a three-year chart on Dover that, like the Disney three-year chart, shows that price growth has been substantial over the last few years. Its P/E has fallen to around 11 because of this hiccup, similar to what the company experienced in April 2010.
To play devil’s advocate, here is one theory why Dover may drop a bit further until the correction occurs: Because Dover is generally low-volume, analysts are slow to update their targets, so some upcoming price targets that to not meet previous expectations, like this one, may send the stock lower, but they will still be higher than $50.
In conclusion, in times of economic volatility, there will be value plays popping up left and right. In picking them you must have faith that the underlying company will prevail through the adversity and continue to generate returns for years to come. Here we have two companies that have succeeded for years and will be here decades down the road.
Disclosure: I am long DIS, DOV.