It is no secret that asset prices are getting stretched due to low interest rates and a reach for yield on the part of investors. It is getting increasingly more difficult to find quality companies that trade at reasonable valuations.
One such quality company that is not trading at 20+ P/E ratio is Disney (NYSE:DIS). It has a great brand and a portfolio of world class businesses that span the globe, yet it has fallen ~25% from its all-time high valuation of ~$122 registered in August 2015.
Most of the recent weakness experienced in Disney stock is related to the well-documented (and priced in) news around cord cutting and concerns around its ESPN unit. Furthermore, there has been chatter around Disney being potentially interested in acquiring Twitter (NYSE:TWTR)- which for the most part has been discredited but still hangs over the head of the stock price as a potential drag should the rumors prove true.
This is where having a long-term horizon becomes a competitive advantage. One does not need to time their purchases perfectly. In fact, I don't mind overpaying for a quality company such as Disney, Nike (NYSE:NKE) or Starbucks (NASDAQ:SBUX) by 10%, 20% or even 30% - especially if I am starting a position in such companies that don't provide many buying opportunities for investors.
Furthermore, I am fully prepared (in fact, hoping would be more accurate) to continue buying if the stock price declines another 10%, 20% or even 30% for I know that over a 10+ year period, picking up quality companies at such substantial discounts will greatly enhance my returns and more than compensate for my inability to time the stock market.
In Disney's case for example, I have started adding to my positions after the stock fell below $95 (I have been a long time Disney stock holder but have not purchased more shares until recently). From 2011 to 2015, shares of Disney seemed to be climbing a perfect straight line, when in August of last year it hit what seemed like a road block at ~$120.
Even so, Disney's earnings kept climbing, from a ~$4.9/share in Fiscal 2015 ($5.15, excluding the effect of a deferred income tax asset write-off - source: Disney 2015 Annual Report) to an expected ~$5.8/share this fiscal year ending September 30, 2016 - source: Marketwatch.com. The company is scheduled to report Fiscal 2016 and Q4 2016 results on November 2016.
So if the stock recovers to its all-time peak of $122 in the next 10 years (which also happens to be my low-case scenario (see table below: P/E compressed to 13X and 9.42 EPS expectation after 10 years of compounding of 5% - less than half of what Disney achieved in the past 10 years), add in a 1.5% yield, I expect to make ~50% total return. However, if the stock declines to $80, I plan on adding to my position and these shares I expect would return ~75% over the next 10 years - again, based on what I expect to be a low-case scenario. If I use a $170 expected price for DIS in 2026, including dividends, I expect to roughly double the money I invest at today's prices.
|2026 P/E Multiple|
|$14.99 (10% EPS CAGR)||$ 194.89||$ 224.88||$ 254.86|
|$11.37 (7% EPS CAGR)||$ 147.81||$ 170.55||$ 193.29|
|$9.42 (5% EPS CAGR)||$ 122.40||$ 141.23||$ 160.06|
Source: Author's Work
However, based on Disney's ramped up stock repurchases (more on this below) coupled with organic growth coming mainly from Disney's theme parks (with strong pricing power), and other divisions, I believe Disney can achieve 10% annual EPS growth over the next 10 years. As the table below shows, this is still below the 13% Disney achieved over the past decade (a combination of 11% earnings growth and a 2% per year decline in shares outstanding). With its decline in share price, Disney has accelerated its share repurchases to about $2B per quarter (or roughly 80M shares/year, or 5% of outstanding shares).
|2006||2016||Annual Growth Rate|
|Revenue||$ 33,747||$ 56,002||5%|
|Earnings||$ 3,374||$ 9,589||11%|
|EPS||$ 1.64||$ 5.78||13%|
|Dividends||$ 0.27||$ 1.42||18%|
Source: Author's Work, Morningstar.com
Thus even with a 5% earnings growth, coupled with the aggressive share repurchases, Disney can grow EPS at 10% year, resulting in what I believe to be a realistically achievable $225 share price a decade from now, at a 15 P/E multiple. As shown in the table below this translates to a 137% price gain (higher based on today's closing price of ~$92 on Wed, 10/12).
Combined with dividends, I think one can realistically expect to make over 150% in total returns from Disney in the coming decade - and substantially more if the stock declines further and one continues to accumulate shares at lower prices. In fact, another 15% decline in the stock will give one an opportunity to triple their investment in 10 years (including dividends) should they continue to buy at $80.
|2026 Share Price Potential Returns|
|DIS Purchase Price||$120||$170||$225|
Source: Author's Work
A note on Valuation, Dividends and Share Repurchases:
Over the past decade, Disney Has grown its Revenues from $33.7B to $56 B, a compound annual growth rate of 5%. It has grown its bottom line from $3.4B to $9.6B at 11%, more than twice the rate of revenue growth and throw in a 2%/year share count reduction driven by share buybacks, EPS has grown at 13% CAGR.
The company has grown earnings both organically and by acquisition. Over the past decade or so, Disney has spent billions acquiring Star Wars for $4 billion (press release), Marvel for $4 billion (press release 2) and Pixar for $7.4 billion (NY Times Ariticle). The rumored Twitter (NYSE:TWTR) acquisition notwithstanding, Disney has proven itself to be an able acquirer and integrator of new business.
Thus, even with a stagnant ESPN division (which happens to be the largest business within Disney's portfolio) making $18B of its total $42.5B in Revenues over the last 9 months and close to half of its $12.5B in Operating Income in the corresponding period, Disney's other businesses are showing healthy growth and diversification to maintain organic revenue and earnings growth (source: Disney 3rd quarter Earnings Release).
As mentioned above, if the share price remains at these levels, I expect Disney to maintain its aggressive stock repurchase program as the pullback in the stock price has not gone unnoticed in Disney's part either. The company has more than doubled up its stock buybacks in the first nine months of fiscal 2016 (ended Jul 2, 2016) to $5.9B compared $2.8B to the first nine months of fiscal 2015 (ended June 27, 2015) (source: Disney Earnings Release).
The share buyback amounts are significantly larger than the dividends paid ($1.1B and $1.9B for the first 9 months of the fiscal 2016 and 2015 respectively - the 2015 number is higher due to a timing anomaly where the company switched to twice a year dividend payments from once a year dividend payment). With its sub 2% dividend yield and lack of stock momentum, the stock is not considered a dividend play by dividend investors, or a momentum play by momentum investors. This gives an opportunity for long-term investors focused on fundamentals and valuation who can wait out the noise an opportunity to buy the shares without having to compete with dividend or momentum investors.
This is not to say that Disney cannot be bought for its dividend. Share repurchases are not the only way Disney management is returning capital to shareholders. They have increased their dividend from $0.27/share in 2006 to $1.42 in 2016 (source: Morningstar.com). This is a CAGR of 18% over a 10-year period. Even so, the dividend payout of the company has remained relatively low, increasing from 16% of earnings to a still low 25% of earnings.
If the company maintains the dividend payout at ~25% of earnings, one can expect the company to increase its dividend to $3.75 in 2026 and an investor can expect to collect $27 in dividends over the next decade, based on what I believe to be a realistic EPS growth scenario of 10%/year through a combination of organic growth, acquisitions and share buybacks.
|DIS Dividend Projections for Various EPS Growth Rate Assumptions (25% payout ratio in 2026)||TOTAL DIVIDENDS COLLECTED|
|10% Earnings Growth||$ 1.42||$ 1.59||$ 1.75||$ 1.92||$ 2.12||$ 2.33||$ 2.56||$ 2.82||$ 3.10||$ 3.41||$ 3.75||$ 26.75|
|7% Earnings Growth||$ 1.42||$ 1.55||$ 1.65||$ 1.77||$ 1.89||$ 2.03||$ 2.17||$ 2.32||$ 2.48||$ 2.66||$ 2.84||$ 22.78|
|5% Earnings Growth||$ 1.42||$ 1.52||$ 1.59||$ 1.67||$ 1.76||$ 1.84||$ 1.94||$ 2.03||$ 2.13||$ 2.24||$ 2.35||$ 20.50|
Source: Author's Work
The market does not give a lot of opportunities to buy great businesses without a significant premium. Disney, due to its well documented, but what I believe to be temporary, challenges has lagged most of its peers in the DJIA this year and is giving an opportunity to investors to buy this great company at a reasonable valuation of 17 trailing P/E multiple.
While investors with significant existing positions in Disney may wish to wait for a better entry point as the market may have pullbacks in the future due to stretched valuations as well as the Fed increasing rates, the recent $92 price provides an attractive entry point for investors to start building new positions and to continue accumulating shares in the event of future pullbacks.
Based on what I believe to be conservative estimates that are below what Disney achieved in the past decade, I would expect investors buying now to more than double their investment in the coming decade and potentially triple if the stock declines another 10-15%.
Disclosure: I am/we are long DIS.
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.