by Ben Reynolds

Walt Disney Co (NYSE:DIS) has a market cap of $157 billion. Giant corporations don’t grow fast, but someone forgot to tell Disney that.

The company has doubled its earnings-per-share from 2010 through 2015.

Rapid growth is nothing new at Disney.  From 1962 to the present Disney has generated compound returns (including reinvesting dividends) of 14.6% a year.

Every $1 invested in Disney in 1962 is now worth $1,580.29.  The image below shows the growth of $1 invested in Disney through time.

DIS Growth over Time

Price Matters

Growth usually comes at a price in the stock market – especially for well-known businesses.  The price you pay matters.  The Warren Buffett quote below drives home this point.

“Price is what you pay.
Value is what you get”

Take Cisco (NASDAQ:CSCO) as an example. Cisco is an industry leader.  The company generates tremendous earnings.  Earnings-per-share have more than quadrupled for Cisco since 2000.  If you bought into the company thinking it would grow in 2000 – you would have been correct…

But your investment account wouldn’t have fared too well.  That’s because Cisco was wildly overvalued in 2000.  It traded for an average price-to-earnings ratio of 100.

CSCO Price
What’s interesting about an investment in Disney right now is that investors don’t have to pay for its growth prospects (growth prospects will be discussed later on in this article).

Here’s how Disney stacks up versus the S&P 500 right now:

  • Disney has a price-to-earnings ratio of 18.0
  • The S&P 500 has a price-to-earnings ratio of 22.6

Based on its price-to-earnings ratio, Disney’s growth prospects should be worse than that of the overall market.

I strongly believe that Disney has better total return potential than the average S&P 500 stock.  I believe Disney to be somewhat undervalued at current prices.

Disney Business Overview

Disney operates in 4 segments.  The % of total operating income each segment generated for Disney in its most recent quarter is listed below:

  • Media Networks generated 33% of operating income
  • Parks & Resorts generated 23% of operating income
  • Studio Entertainment generated 24% of operating income
  • Consumer Products & Interactive Media generated 20% of operating income

The studio entertainment section’s operating income grew 86% due to the release of the newest Star Wars movie.

Here’s a brief summary of what Disney owns in each segment is below.

The media networks segment owns ESPN (80% ownership), ABC Family, Disney Channel, The A&E Network (50% ownership – includes A&E, History Channel, and Lifetime), the ABC television network, 8 large market domestic television stations, and Hulu (33% ownership).

The parks & resorts segment owns:

  • Walt Disney World in Florida
  • Disneyland in California
  • Aulani in Hawaii
  • The Disney Vacation Club
  • The Disney Cruise Line
  • Adventures by Disney
  • Disneyland in Paris (51% ownership)
  • Disneyland in Hong Kong (48% ownership)
  • Disney Resort in Shanghai (43% ownership)
  • Disney Resort in Tokyo (not owned, licenses operations)

The studio entertainment segment owns some of the biggest brands in entertainment.  This includes Walt Disney, Pixar, Lucas Films, Marvel, and Touchstone.

The consumer products & interactive media segment licenses the company’s intellectual property to create toys, games, merchandise, and apparel.

Why Disney Is Cheap

Disney stock has declined around 20% from all-time highs.

The decline is driven by fear over the company’s media networks segment.  The majority of the segment’s revenue comes from cable affiliate fees.  The cable industry is expected to slowly decline as competition from streaming services gains market share.

Indeed, cable network operating income declined 5% in the company’s most recent quarter.  Overall, the company realized 20% operating income growth in the quarter due in large part to surging sales from Star Wars.

Investors are overreacting to changes in content delivery.  To understand why, one needs to understand Disney’s competitive advantage and growth prospects.

Competitive Advantage and Growth

Think about this – Disney’s operating income as a company grew 20% in its latest quarter while cable network operating income declined 5%.

Disney’s real strength is not its deals with cable companies.

Disney’s competitive advantage is its amazing stockpile of intellectual capital.  The company owns ESPN, Frozen, Marvel, Star Wars, Mickey Mouse, and the Muppets, among many, many others.

Whether it’s through streaming services or cable, consumers will pay money to watch quality entertainment.  That will not change.

Disney has a strong and durable competitive advantage thanks to its well-known entertainment brands.  The company has also shown the ability to either acquire (Marvel, Star Wars) or create (Frozen) multi-billion dollar brands.

Best of all, this competitive advantage is not based on technology.  Will changes in the way we watch content create change at Disney?  Absolutely.  Will it mean we stop caring about Star Wars, the X-Men, or Elsa, Anna, and Olaf?  I don’t think so.

Disney’s long-term returns over the last ~50 years are phenomenal.  There are very few companies that can generate double-digit growth rates decade after decade.  Disney is one of them.

The company has compounded earnings-per-share at 13.2% a year over the last decade.  Disney’s growth has not slowed much from its long-term historical average.  Imagination and fantasy are still in high demand.

The company’s management has done a good job of returning money to shareholders as well.  While Disney does not have a high dividend yield, the company does regularly repurchase shares.  Disney has reduced its share count by 2.8% a year over the last decade.

Share repurchases combined with the company’s 1.5% dividend yield give investors a shareholder yield of 4.3%.  Disney pays out more earnings to shareholders through dividends and share repurchases than it invests itself.

I expect Disney to generate total returns in excess of 10% a year for shareholders.  The company will continue to compound shareholder wealth by capitalizing on its unrivaled entertainment brand portfolio.

On Disney’s Low Yield

Disney is a great business trading at a reasonable valuation (which it is)…

But many dividend investors find it difficult to invest in Disney.  The company’s dividend yield is just 1.5%.  This is below the S&P 500’s dividend yield of 2.1% and well below what most dividend investors look for.   A comment about Disney’s dividend yield from this analysis of the company shows the concern about the company’s low yield:

“DIS is definitely a tough one for dividend investors. I tend to dismiss a stock that yields under 2% as a non dividend stock. As you point out though there is more to investing that yield when you are in it for the long term and total return after dividend growth. Lots of positives for the future.”

There is no question that Disney is not a suitable investment for someone needing high levels of current income.

Investors seeking long-term total returns would be wise to consider Disney despite its lower-than-average yield.

The company’s growth prospects, share repurchases, and reasonable valuation make it likely that Disney will generate superior returns over the long run – in spite of its low dividend yield.

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