On Thursday, April 11 2019, Disney (DIS) announced it will be providing a $6.99 per month streaming service called Disney Plus. This news was a direct threat to Netflix’s core business, which charges $13 monthly fee. Netflix’s shares fell 4.5% to $352.14, and Disney’s stock jumped 11.5% to an all time high of $130 per share. Disney’s CEO, Bob Iger, said that Disney is entering the streaming business from a “position of strength, confidence, unbridled optimism”. Leaving the recent price action (noise) in the stock aside, I will talk about the fundamentals of Disney. The question I will address in this blog post is if Disney stock is a buy or not.
Let me start off by saying that Disney has a competitive advantage going into the streaming service business. People are willing to happily spend their money and watch Disney movies and shows because they know that they won’t be disappointed for making that purchase. As a value investor, I like this. Disney, the brand name, itself is a moat. Let’s look at some ratios to better understand the fundamentals of Disney:
- Current Ratio and Debt/Equity Ratio – Current Ratio is the ratio of current assets to current liabilities. While analyzing the balance sheet for 2018, I noticed that Disney had a current ratio of 0.94. I would want this number to be at least a 1.00; the idea is that a company should have enough “current assets” to pay off its “current liabilities”. Eight of the past 10 years, Disney had a current ratio above a 1.00. In fact, the current ratio for the most recent quarter (Q1 2019) is 1.00. So, looking at the most recent picture (balance sheet) of the company’s health, Disney’s current ratio is in the green. Now, you might look at Netflix’s current ratio and notice that it is 1.49. This means that Netflix has 1.49 times more current assets than its current liabilities. Don’t quickly assume that Netflix is better than Disney. It is important to note that current ratio does not account for those long term “non current” debts/liabilities. To fill in this blind spot, the Debt to Equity ratio gives us a better understanding of the financial health of the company. Netflix’s Debt/Equity ratio is 1.98. This means that for every dollar that Netflix has, it has borrowed close to two dollars. In contrast, Disney’s Debt/Equity ratio is 0.34. In other words, for every dollar than Disney has, it has borrowed 34 cents. Warren Buffett prefers the Debt/Equity ratio to be 0.5 or lower. So, Disney has passed that test with flying colors. You can compare this concept to 2 individuals who have $100,000 in their bank accounts; one of them owes $34,000 and the other one owes $198,000. If you were to pick one, who is likely to succeed in the long run, who would you pick? I would pick the individual who owes $34,000 since his debt is under control and manageable.
- Return on Equity – Once I knew that the company’s debt is under control, I looked at the Return on Equity (ROE). Equity is the money that I (shareholder) invest in the company by buying its shares. The ROE number lets me know what return I would get on my investment. As an investor, I want to see the ROE stay steady or grow over a period of 10 years. I notice that Disney’s ROE has been steadily growing from 10.01% in 2009 to 27.97% in 2018. Having a return on equity above 8% consistently is a good indicator of great management. Disney’s management knows where to invest the shareholder’s equity such that the shareholders receive a good return. Now, looking at the future, the CEO of Disney, Bob Iger, plans on stepping down in 2021. Iger has been the CEO of Disney since 2005. As an investor, I am always worried when there is a change in management. You do not know what vision the new CEO might have. The new CEO might scrap business ideas that were envisioned by Iger. In other words, the ship is getting a new captain in 2021, and we don’t know where that person would take the ship.
- Book Value and Earnings Per Share – Stable and understandable businesses are key to investment success. It is important to see the stability and growth of Book Value (BV) per share and Earnings Per Share (EPS). The BV is the net asset value of a company i.e. total assets minus intangible assets (patents, trademarks, copyrights) and liabilities. It is understandable for Disney to have low BV since it has a lot of intangible assets. Earnings is the net income of the business; it is also referred to as “bottom line” since it is the last line on the income statement. Looking at BV and EPS over a 10 year period, I notice that both the numbers have steadily increased every year. BV per share has increased from $18.15 in 2009 to $30.73 in 2018, and EPS has increased from $1.76 in 2009 to $8.36 in 2018.
I looked at multiple other ratios such as Gross Profit Margin Ratio (which tells you how much sales is actually profit), Operating Margin Ratio (gives you an idea of how efficient the company is), Return on Assets, Interest Coverage Ratio, Free Cash Flow to Revenue Ratio, etc. Fundamentally, Disney looks like a solid company. The question that I need to address now is whether Disney’s current stock price ($130/share) is attractive or not. As a value investor, I have to make sure that I buy a stock at an attractive price so that I have an adequate margin of safety. Let’s find the intrinsic value of Disney:
Disney had Free Cash Flow (FCF) of $9,830 million in 2018, and 1507 outstanding shares. By assuming an annual growth rate of FCF of 5%, long term growth rate of 3%, and a discount rate of 10%, the intrinsic value per share comes out to $108.49 (Discounted Cash Flow Analysis). If we decrease the discount rate to 8.75%, the intrinsic value per share comes out to $133.48. This means that by using the 2018’s FCF, outstanding shares, and the assumptions above, if you were to buy the stock at $130, you would expect to get a return of about 8.75% every year. Alternatively, by taking into account the FCF for the past 10 years, the expected rate of return if the stock is purchased at the current price of $130 is 5.3%. In comparison, the zero risk 10 year US Treasury note gives you a return of 2.56% (as of Friday, April 12, 2019). To me, a 2.74% (5.3% minus 2.56%) margin of safety is not adequate. While taking into account the fundamentals of Disney, some of you might find a 2.74% margin of safety to be reasonable.
In Chapter 8 of the Intelligent Investor, Ben Graham (the father of value investing) advised investors never to buy a stock immediately after a substantial rise or sell one after a substantial drop. In other words, it would be wise to keep Disney on your back burner and wait for a future drop in price (i.e. more attractive price) rather than buying this stock after the recent 11.5% increase in price. I have been a Disney shareholder for a few years now, so while writing this blog, I was actually checking up if my investment is still sound in 2019. I still find this investment to be good, and plan on holding my shares for years to come.
Hope you learned a little and found this blog post helpful. We talked about different ratios and numbers that show if Disney is worth buying or not. Hopefully you got a better idea of the fundamentals of Disney. As always, you can sign up for our mailing list here. Like us on our Facebook page here. Thank you!
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