Walt Disney Co. [DIS] — Value Investing

Today I am going to evaluate Walt Disney as a company and as a possible stock investment using what I have learned so far with regards to value investing. A bit of a long post, but hopefully of interest to those interested in stock market investing, especially value investing.

Company Profile

Name: The Walt Disney Company
Symbol: DIS
Market Cap: 172.1 bil
IPO date (NYSE): 1957
Expectation: Great solid company, but overvalued
The Walt Disney Company might be one of the most well known companies and brand names we have today. Founded in 1923 by Walt Disney and Roy O. Disney under the name “Disney Brothers Cartoon Studio”, it has grown to the second biggest media conglomerate in terms of revenue (behind Comcast) and it operates an incredibly diversified portfolio including live-action, animation, and cartoon film production, television, theme parks, merchandise & products, and more. I use their products at least on a weekly basis, as my girlfriend and I are quite the Disney movie fans. Not to mention my little sisters…

Future Prospect Glimpse

Before I dive into a company I like to ask myself a few questions with regards to its future outlook. Even though a more thorough analysis is required for the eventual decision, this will help me weed out the companies I should not even be considering in the first place. I strongly believe in value investing as the way to go. One of the important things of this strategy is to hold on to stock for over a relatively long period of time in order to benefit from its cumulative growth and the long term capital gains tax (even though I am a resident of the Netherlands, I am using the US tax system as a guideline). The idea therefore, is to only invest in companies that suggest a strong future in over 20 years, if one at all. So, to get to the questions.

How is the industry and the company doing?
As mentioned before, The Walt Disney Company is active in many different fields, but for the sake of clarity we will place it in the “Media — diversified” industry. There are big changes happening in the media industry. We are rapidly moving away from cable television and the internet has become a mainstream entertainment player, even more so than it already had been for over the last decade. On-demand movies and series via platforms from the likes of Netflix, HBO, and HULU, have been an answer to illegal streaming and downloading of movies, returning lost revenue into the pockets of all involved in making it, but it is still a question whether the businesses are going to sustain. Also, cinemas have seen their visitor numbers drop over the last 15 years, but they seem to have found an answer by raising prices resulting in ever growing box offices. At the same time there is another completely new entertainment system being brought into the market at rapid pace: Virtual Reality. All very interesting trends that will define the way we consume movies and series, but it is hard to tell how it will develop. With regards to theme parks, they are as interesting for kids and adults right now as they were decades ago (though more accessible), and I see no reason why they will not continue this trend in the future.

The Walt Disney Company is completely on top of its game. They are releasing amazing and highly rated Disney movies every single year ranging from animations that are big hits like Moana, Zootopia, Big Hero 6, and Frozen, and with their acquisitions of Marvel and Lucasfilm (Star Wars franchise) have an amazing line of live actions under their name. Their top 3 theme parks alone bring in over 55 million people annually and their numbers are still growing. 8 of the 10 most visited theme parks in the world are under Disney’s name, with the other two being from Universal (#4 and #8).

Disney has shown an incredible competency to adapt to rapid changes in their industry over the last decade, and with Bob Iger as their CEO I am confident that they will do so for the upcoming decades as well.

Grade 1 Evaluation — Returns (1)

The following ratios are used to get some preliminary insights in the returns and stability of the company.

P/E and P/B
The first numbers, or ratios if you will, that I normally look at are Price-to-Earnings and Price-to-Book. These numbers can give you a snapshot of a companies expected returns as well as an idea of their valuation v market price. 
P/E is calculated by dividing the total market capitalization by the net income (or earnings), or on a share level, the price of the stock per share divided by the EPS. It gives you, in essence, the number of years it is expected to take to gain 100% of your invested capital. A P/E of 13.5 basically means that it will take 13.5 years before you have gotten the share price back as a return. Or in other words, it means that for every $13,50 dollar you invest, you get $1,- in return annually. 
P/B is calculated by dividing the total market capitalization by the shareholders equity, or — again — on a share level, the price of the stock divided by the book value per share. This gives you an idea how much higher the stock is priced compared to the total equity that is left after a liquidation of the company at that very moment (after all assets are used to pay off all liabilities).

Price-to-Earnings: 18.9 (this is higher then I’d like to see, especially with the book value being high).
Price-to-Book value: 4.0 (this is way to high, and we will probably see this back later as the company being overvalued).

Stable EPS, book value, and dividend growth
Stability is key in being able to determine a company’s intrinsic value, but evidently we do want to see the company improving over time. Since the EPS is what basically manifests itself in a shareholder’s returns (namely into book value or dividend), we want to see stability and growth in all these areas.
EPS went from 2.25 in 2007 to 5.73 in 2016, with a slight dip during/after the crash of 2009 with revenues only dropping 5% and immediately picking up the year after.
Book value per share went from 16.0 in 2007 to 27.50 in 2016 with consistent growth, up to 2015-2016 when it dropped from 27.56 to 27.50.
Dividends had a solid growth from 0.31 in 2007 to 1.81 in 2015, but then dropped in 2016, down to 1.42. This, combined with the book value drop we see in 2016, is something we need to properly look at. A company only drops its dividend when its really necessary, because doing so often has an immense impact on their stock price. They did raise it from 0.86 to 1.81 in 2015, which might have been a bit on the high side.

After the poor P/E and P/B, we already kind off know this is not an attractive stock to buy at this moment, and the slowdowns over the last 2 years mentioned above are also not great. However, if all the other fundamentals turn out to be good, it might be an good idea to put it on our watch list and see whether things get better.

Grade 2 Evaluation — Debt & Returns (2)

Now we look at how the company deals with liabilities, whether their ratios are good or are of concern, and a few more indicators of good growth.

Debt-to-Equity & Current Ratio
We look at these two ratios because they can give us an indication of how the company deals with taking on and paying off debt, and whether we should be concerned about it.
Debt-to-Equity is a ratio that does what it says; it divides the total debt (both short- and long-term) by the shareholder’s equity. It gives us an idea of how easy the company’s management takes on debt and whether the company is very much self-sustaining or dependent on outside capital. Preferably we want to see a Debt-to-Equity ratio that is lower than 0.5 (meaning the equity is twice as large as the total debt).
The Current Ratio is calculated by dividing the total current assets by the total current liabilities, and gives us an indication, again, of how dependent a company is on outside capital. It basically asks “If the company would have to pay off all their current liabilities right now, would it be able to using its current assets?” Preferably I want to see a Current Ratio that is higher than 1.5.
Also, for both ratios we want to see stability (preferably moving in the right direction) over the last 10 years.

Debt-to-Equity: 0.38 (which is good according to our criteria. Though, after 4 years of stability around 0.29, last year (2016), it jumped up to 0.38. Not a fantastic sign.)
Current Ratio: 1.01 (which is much lower than we want to see. Also, it has been on a dropping course from 1.21 in 2013. Also, not what we want to see.)

Again, after having seen this combined with the ratios mentioned in Grade 1, I would decide NOT TO BUY. Though, for the sake of this post I am going to evaluate all the way through the company.

Return-on-Equity and Projected Earnings
The Return-on-Equity is a great ratio (Warren Buffett’s favorite number) because it shows how well the company is using its resources to make a profit. Better framed, the ROE is an indication of how much the company expects to return on the equity of the company (duh). It is almost a direct indication of our expected return on the stock as an investor, because it says “For every $1 of equity we expect a return of so many cent.” The return that the company makes, the EPS, is going to be converted in a book value growth (into the equity of the company) or will be paid out as dividend (our direct earnings on the stock). A part will probably be lost in depreciation and replacements that do not convert to extra equity, but in general it gives us an idea of what we can expect. Again, ideally, we want the ROE to be on a stable growth trend, though consistency is also enough, preferably roaming above the 10%. If it is dropping significantly over the years, that is something to take into account.
Projected earnings is another thing we want to look at. The only thing we care about is that the earnings are projected to grow at roughly the same rate as we expected after evaluating the last 10 years.

Return-on-Equity: 21.39% (and on a growing trend, which is really just incredible)
Projected Earnings: 3.7% growth 2017, and 12.8% in 2018 (very good)

Grade 3 Evaluation — Value

The core of value investing is comparing a companies market price to its intrinsic value. The intrinsic value is an estimate we make on what a company is really worth. The market price often does not reflect this. Moreover, the market price, whether too high or too low, is often based on irrational assumptions made by momentum traders and the general public. As a value investor I want to find companies that show strong fundamentals and that are likely to continue an upwards trend over the next 20 years — even though it might fluctuate around this trend line. We want to get in when a company like this is undervalued, so our potential return will be higher and our risk of loss decreased (margin of safety). Also, and we will do this first, we look at the company’s cash flow statement to get an idea of their trajectory with regards to taking on debt, re-investments in the company, stock buy-backs or stock investments, and so on.

Cash Flow Statement 
Consistent, stable growth over the last 5 years in net cash from operating activities, which is a good thing. It nearly doubled from 7,966 in 2012 to 13,213 in 2016 (all numbers are in millions. Except the dates, of course…).
Consistency in cash expenses on investment activities, which is a good thing. This shows the company invests its earnings back into the company.
Consistency and growth in cash going out for finance activities over the last 5 years. This is good because it shows the company is repaying its debts, paying out dividends and repurchasing stock, at a higher rate than it is taking on new debt.
Overall, this is a very good cash flow statement. Though, we see an increase in debts being issued in the last year (2016) which coincides with the increase in Debt-to-Equity ratio noted before.

Intrinsic Value
In order to calculate the intrinsic value of a company I use a formula that takes into account the ratios and criteria mentioned above that focus on potential returns, like book value and dividend growth, and include the average rate on a (no-risk) US treasury note/bond of 10 years as a comparison.
I estimate the intrinsic value of the stock of The Walt Disney Company (DIS) — using the current rate on a US treasury bond of 2.49% — is: 
Comparing this to the current stock price of $109.30 (01/28/2017) I am convinced that this company’s stock price is highly overvalued.
The corresponding quantitative margin of safety becomes -112.36%. We want to see a quan margin of safety of at least 20%. This, clearly, is a No-Go.

Recap and Decision

If a company would have shown outstanding strength on all fronts in Grade 1 to 3, I would dive into the company much further to evaluate its management, its customers, and []. However, as mentioned earlier on in this piece, I already made up my mind about the stock, and the valuation compared to its current market price made it an even more straight forward decision.

The Walt Disney Company is an amazing enterprise. There is hardly any company that is more diversified and famous as is Disney. Though it has shown great strengths for over decades and decades, and I expect it will do so in the future, right now I decide not to invest. This because 
1) the company is just plainly highly, highly overvalued and I expect it to slowly pull back to a more accurate representation over the years (does not mean it has to drop, just that I believe the current growth trend might significantly slow down, and the risk associated does not way out), and;
2) though the company has shown impressive ratios and stats, 2016 was not a good year with some worrisome numbers/trends in D/E, dividends, Current Ratio, and book value. It is definitely one to keep an eye on to see what 2017 brings, and see whether a better buy opportunity might arise in the next few years.


DO NOT BUY, but put on watch list.

Thanks for taking time out to read through this very long post. This was my first stock evaluation post, and from now on I am going to make them a bit more concise, having introduced my evaluation criteria. I hope you enjoyed it and if you want to share any thoughts, feel free to leave a comment. You can also follow me on twitter @ thumpertje

Have a good one!

Valentijn van den Hout