Disney: Great Company, Not So Great Price

| About: The Walt (DIS)


There is a lot to like about Disney. It is a solid company, which should be owned by patient long-term money.

But as priced, Disney offers negative alpha of 117 basis points. It is a good company, not trading at a good price.

Valued relative to the market, Disney gets attractive at or below $82.40. However, on a stand-alone basis (ignoring relative value), $76.40 or below is attractive for patient long-term money.

Value Line research recently issued an updated report for Disney (NYSE:DIS). You can download that report here. They hiked their 2017-2019 price target range from $85 to $100 in their report of 5/9/14 to $95 to $115 in their report of 8/8/14.

Value Line awards Disney a safety rank of 1. This means that the total risk of the stock relative to the approximately 1,700 other stocks covered by them in The Value Line Investment Survey®, is low.

They award the stock a timeliness rank of 3. This means that the probable price performance of the stock relative to the approximately 1,700 other stocks covered by The Value Line Investment Survey® during the next six to twelve months can be expected to be in-line.

They also assign the stock a top financial strength rating of A++. Value Line classifies 1,700 companies' Financial Strength ratings from A++ to C, in nine steps. The lowest grade is reserved for companies experiencing serious financial difficulty. Balance sheet leverage, business risk, the level and direction of profits, cash flow, earned returns, cash, corporate size, and stock price, all contribute to a company's relative position on the scale. The amount of cash on hand, net of debt, is also an important consideration.

With Disney we are looking at a company with low risk and high financial strength, with an expectation of inline performance over the coming six to twelve months.

I like Disney the company and think it is a great pick for the consumer discretionary sector for long-term investors. However, in my view it is not well priced at present. I will keep the stock on my radar to see whether it dips enough to offer an opportunity to create alpha in the coming months.

Value Line computes a beta for Disney of 1.1. I calculate the raw beta based on the five-year regression of weekly closing prices of the stock, relative to weekly closing prices of the S&P 500 at 1.18, and I adjust it to 1.11 on account of the beta's tendency to converge towards one. The coefficient of determination for Disney is 62.58%. This suggests that 62.58% of the price movement in Disney is explained by movements in the market: the residual price movement is based on company-specific factors. This coefficient of determination suggests that the market related risks are high - if the market declines, we can expect Disney to follow suit.

Over the past five years, the average weekly price change on Disney has been 0.495% (median 0.35%). The standard deviation over the period has been 3.11%. Thus for Disney, the range of normalcy (average plus or minus one standard deviation) for weekly returns is between a gain of 3.6% and a loss of 2.61%.

Source: MaxKapital Beta Calculator

Over the past five years, the average weekly price change on S&P 500 has been 0.266% (median 0.31%). The standard deviation over the period has been 2.09%. Thus for the S&P 500, the range of normalcy (average plus or minus one standard deviation) for weekly returns is between a gain of 2.36% and a loss of 1.83%.

Source: MaxKapital Beta Calculator

From this it is clear that Disney is more volatile than the S&P 500, and it is also clear that Disney investors have been rewarded for their acceptance of higher than market volatility.

If you notice, downside volatility in the S&P 500 has risen recently. It has remained contained for Disney. Given the high co-efficient of determination for Disney, I would expect to see downside volatility for Disney before long, provided that the S&P 500 remains weak.

What might Disney be worth to me? Disney recently traded at $85.51. Value Line has a 2017 to 2019 price target range on the stock of $95 to $115. If the stock hits the mid-point of their targets by 12/31/2017, investors will have earned an annualized return of about 6.23%. This together with the present dividend yield of 1.01% implies a total annualized return expectation of 7.24%.

I estimate the cyclically adjusted equity risk premium at 4.72%, and the long-term risk free rate at 3.22%. Thus my market total return expectation is 7.94% (4.72% plus 3.22%). This is somewhat lower than the customary 9% to which investors are accustomed over the very long-term. And it is also below the 10.25% which I see as a reasonable potential very long-term return expectation. The markets are expensive, and if they decline, I expect Disney shall decline somewhat more than the market.

Today, with the S&P 500 at 1,910, my long-term return expectation for the market is 7.94%, while my return expectation for Disney is 7.24%. A lower reward expectation with a higher level of perceived risk does not incentivize me as a buyer. For Disney, a beta of 1.1 implies that investors should target return expectation of 8.41% (1.1*4.72% Plus 3.22%) for it to be worth as much as the S&P 500 on a risk adjusted basis. Thus, as priced, Disney offers 1.17% (8.41% less 7.24%) of negative alpha.

If the stock were to trade at $82.40, while the S&P 500 traded at present levels (1,910), the stock would offer an 8.41% long-term total return expectation. And at this level the stock would offer no alpha and could be seen as rightly valued in the context of the price of stock relative to the price of the market. Buying at this price might make sense if you were under allocated to equity, and if you believed that markets are rightly valued at present. If the stock were to dip below this level, with markets staying at 1,910 or higher, the stock would offer alpha.

If you believe the markets would be rightly priced at a level where they offer a long-term return potential of 10.25%, Disney would be attractively valued relative to the market so priced at $76.40.

When viewing Disney in comparison to the market, the share is attractive at or below $82.40, but looking at absolutes, Disney on a stand-alone basis gets attractive at and below $76.40.

In my view patient long-term money can wait on a better buying opportunity. At the same time, patient long-term money, owning the stock ought to hold the stock - there is a lot to like at Disney.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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