Undervalued Dividend Growth Stock of the Week: Walt Disney Co. (DIS)

When I think about becoming a very successful stock investor over the long haul (say, many decades), I imagine what kind of portfolio would most likely result in that kind of outcome.

I keep coming to the same conclusion.

The kind of portfolio that would most likely result in a ton of success over a very long period of time is going to be filled with some of the best businesses in the world.

These businesses should be more or less household names, providing the products and/or services that the world recognizes, demands, and regularly consumes.

A collection of businesses like that almost can’t do anything but lead an investor to massive success.

Well, that’s my thought process behind being a dividend growth investor.

That’s because dividend growth investing essentially involves buying equity in wonderful businesses.

In fact, these businesses are so wonderful, they’re proficiently producing profit that’s regularly increasing.

And they end up with so much profit, they share a good chunk of that profit with their shareholders via growing dividends.

Jason Fieber's Dividend Growth PortfolioA large enough stream of growing dividends can end up funding one’s entire lifestyle, leading to financial independence.

This thought process, and adhering to dividend growth investing, has led me to constructing my FIRE Fund, which is a real-life and real-money dividend growth stock portfolio that’s valued at well into the six figures.

That portfolio has more than 100 of the world’s best businesses in it. And these companies are sending me regular, reliable, and growing dividends.

That dividend income is substantial.

I’ll lay out just how substantial it is.

The five-figure and growing passive dividend income my portfolio generates on my behalf covers my basic personal expenses in life, rendering me financially independent in my 30s.

It’s pretty incredible to go about my life, at such a young age, completely free to do what I want with my time.

But this portfolio – and the freedom it confers – didn’t take a lifetime to build, nor was it even particularly difficult to do.

I built the bulk of that portfolio in about six years. I saved and invested as aggressively as I could so that I could quit my job at 32 years old and pursue a life completely on my terms.

Best of all, I’ve openly shared that process with you readers through my Early Retirement Blueprint – a “blueprint” that just about anyone can follow to their early retirement dreams.

A major aspect of all of this is, of course, dividend growth investing.

Fortunately, dividend growth investors have a very easy job to do when it comes to finding some of those aforementioned high-quality businesses that are sending their shareholders growing dividends.

David Fish’s Dividend Champions, Contenders, and Challengers list has compiled invaluable information on more than 800 US-listed stocks with at least five consecutive years of dividend growth – and that data is freely available to the community.

Of course, a dividend growth investor’s job is a bit more complicated than picking a random stock off of Mr. Fish’s list and buying it.

A long-term investor has to do their due diligence: quantitative analysis on business fundamentals, qualitative analysis on challenges and opportunities, risk assessment, and, perhaps most important of all, valuation.

See, even a great business can be a subpar investment, especially over the short term, if the price paid at the time of investment is far too high.

Conversely, investing in a great business when it’s undervalued can lead to spectacular benefits.

An undervalued dividend growth stock should extend a higher yield, greater long-term total return potential, and less risk. 

Those dynamics are all relative to what the same stock might otherwise offer if it were fairly value or overvalued.

Price and yield are inversely correlated; all else equal, a lower price will result in a higher yield.

That higher yield obviously leads to more investment income on the same invested dollar.

But that also positively affects long-term total return potential, as investment income (via dividends or distributions) is one of two components of total return.

But it gets better.

The other component, capital gain, is also given a possible boost via the “upside” that exists between the lower price paid and higher intrinsic value.

While the market isn’t necessarily very good at accurately pricing stocks over the immediate term, price and value do tend to more closely align over the long haul.

If you’re able to take advantage of a mispricing in the short term, that can lead to additional capital gain over the long term.

And that’s on top of whatever capital gain is naturally possible as a business increases its profit, becomes worth more, and sees its value (and price) rise over time.

This all has a way of reducing risk, too.

It’s obviously less risky to risk less capital (versus more capital) per share.

Maximizing upside simultaneously minimizes downside.

But you’re also introducing a margin of safety when you buy an undervalued high-quality stock, for it offers a measure of protection against an incorrect analysis, unforeseen challenges, management missteps, or any type of erosion in the company’s performance.

A large margin of safety means something would have to seriously go wrong before you’re “upside down” on your investment (i.e., the investment is worth less than you paid for it).

Undervaluation is clearly beneficial, especially on a high-quality dividend growth stock.

But the process of valuation can seem confusing, especially to newer investors.

That’s precisely why fellow contributor Dave Van Knapp sought to simplify the process through his lesson on valuation, which is part of an overarching series of lessons designed to educate investors on just about everything related to the strategy of dividend growth investing.

It’s Lesson 11: Valuation. And it’s definitely worth checking out.

With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…

Walt Disney Co. (DIS)

Walt Disney Co. (DIS), together with its subsidiaries, operates as a global diversified media and entertainment conglomerate.

They operate across the following segments: Media Networks, 43% of FY 2017 revenue; Parks and Resorts, 33%; Studio Entertainment, 15%; and Consumer Products & Interactive Media, 9%.

So I started this article off noting that the kind of portfolio a long-term stock investor would want to have, is one that is filled to the brim with some of the best businesses in the world.

Well, if you were to take the time to tick off 20 of the best and most well-known companies/brands in the world, it’s pretty likely that Disney would be on that list.

And rightfully so, at that.

It’s an absolute juggernaut in the media space.

When you think of amusement parks, you can’t help but think of parks like Walt Disney World and Disneyland.

When you think about blockbuster movies, names like Avengers: Infinity War, Star Wars: The Last Jedi, and Frozen come to mind pretty quickly. That’s because they’ve all grossed well over $1 billion.

When you think of sports coverage, ESPN comes to mind because it’s The Worldwide Leader in Sports.

And when you think about the domestic broadcast networks, Walt Disney Co. owns one of those, too (via ABC).

Individually, these are incredible businesses on their own.

But what Walt Disney Co. amplifies the power of these individual businesses, and it harnesses more than the sum of the parts.

They do that through cross-promotion and delivering experiences that no other company can rival.

For instance, the Star Wars franchise isn’t so valuable only because of the movies.

There’s also the toys – which can be bought in Disney stores.

And then there’s the theme park experiences, like Star Wars: Galaxy’s Edge. This will allow guests to control the Millennium Falcon. That is a huge competitive advantage that feeds back into the brand via multiple facets.

Of course, Walt Disney Co. won’t stop there.

They’re moving into over-the-top video, where they can leverage their huge library of content and brands that consumers absolutely love. And their OTT product can differentiate itself via exclusive additions (like a new Star Wars television series).

There’s just nothing else like it.

And that bodes well for the company’s ability to pay a growing dividend for years to come.

The company has already made good on that ability through eight consecutive years of dividend raises.

While they kept the dividend static during the financial crisis (which is why the streak is a bit short), they’ve made up for much of that with a monstrous five-year dividend growth rate of 21.1%.

With a payout ratio of just 25.9% (using adjusted TTM EPS), there’s practically nothing but a long runway of dividend growth still yet ahead for this company and its shareholders.

The only dividend metric to perhaps not like is the current yield.

At 1.68%, there’s not a lot of current income for older and/or more yield-hungry investors.

But if you’re a younger investor who isn’t yet living off of dividend income, I think the long-term growth potential should more than offset that low starting yield.

Indeed, the stock was in the $60s just five years ago, back when profit was accordingly much lower.

The company has grown quite a bit in that short period, which has also seen a rapid rise in the stock price. This is a dynamic that will likely continue to play out over many years to come.

So if you have the time to let this company go to work for you, it could be a fantastic long-term holding.

To get further perspective on that underlying business growth, which will later help us gauge future dividend growth and estimate the intrinsic value of the stock, we’ll look at what Walt Disney Co. has done over the last decade in terms of top-line and bottom-line growth.

And we’ll compare that to a near-term forecast for profit growth.

Knowing the past, and then putting that up against an educated guess of the near future, should allow us to extrapolate some ideas about where Disney is going from here.

The company has increased its revenue from $37.843 billion in fiscal year 2008 to $55.137 billion in FY 2017. That’s a compound annual growth rate of 4.27%.

That’s right about what I’d expect from a fairly mature business like this.

However, multiple levers allow the company to log some very strong excess bottom-line growth, as we’ll see.

Earnings per share advanced from $2.28 to $5.69 over this same period, which is a CAGR of 10.70%.

One of those levers is buybacks; Walt Disney Co. reduced its outstanding share count by approximately 19% over the last decade.

Meanwhile, the expanding of net margin only served to exacerbate this effect.

Looking forward, CFRA anticipates that Walt Disney Co. will compound its EPS at a 12% annual rate over the next three years.

That wouldn’t be too far off from what the company already registered over the last 10 years – a period which included a brutal global financial crisis and Great Recession in the US.

This forecast does notably include the announced acquisition of Twenty-First Century Fox Inc. (FOXA) entertainment assets, which ends up being a significant portion of what Twenty-First Century Fox is currently composed of as a media entity.

If this acquisition goes through, it should bolster the possible success of Walt Disney Co.’s move into OTT. It gives the company additional international exposure and an enviable arsenal of ready-made content – on top of what Walt Disney Co. already lays claim to.

That acquisition, though, is far from certain.

Still, we can see what the company is capable of on its own, even straight through a very, very tough decade.

Moving over to the balance sheet, the long-term debt/equity ratio is sitting at 0.46. And the interest coverage ratio is over 28.

These numbers are fantastic. Plus, there’s over $4 billion of cash on the balance sheet.

However, the aforementioned acquisition, if it goes through, would change this dynamic somewhat, at least in the short term.

Profitability is extremely robust. And as noted earlier, there’s been an improvement here that made things even more impressive.

Over the last five years, the firm has averaged annual net margin of 15.63% and annual return on equity of 18.47%.

This is an amazing company. The fundamentals speak for themselves.

Furthermore, the competitive advantages, principally in the sense of being able to use individual properties to complement related businesses across the company, are unique and huge. It’s a case where the sum of the parts exceed the whole, in my view.

However, cord-cutting and its impact to certain media assets (ESPN in particular) is a risk.

Competition is another risk, of course.

And since most of the company is exposed to discretionary consumer spending, any major slowdown in the economy could affect the bottom line. The parks, for instance, are exposed to cyclical spending.

But the valuation makes this a very compelling long-term idea right now…

The P/E ratio is sitting at 15.43 right now. That’s using adjusted TTM EPS. I factored out the one-time gain the company registered in Q1 FY 2018 related to US tax reform (which would have otherwise given the stock an artificially low P/E ratio).

That is significantly below the stock’s five-year average P/E ratio of 20.2. It’s also well below the industry average. And it’s obviously way under the broader market’s multiple.

The current P/CF ratio is 10.6. Compare that to the stock’s three-year average P/CF ratio of 15.1.

Meanwhile, the stock’s yield, while low, is almost 40 basis points higher than its five-year average.

So the stock does look cheap here on multiple fronts. But how cheap might it be? What would a reasonable estimate of intrinsic value look like? 

I valued shares using a two-stage dividend discount model analysis (to account for the low yield/high growth dynamic).

I factored in a 10% discount rate.

I assumed a dividend growth rate of 13% for the next decade.

And then I assumed a long-term dividend growth rate of 8% thereafter.

These long-term dividend growth rates look pretty rational to me.

With the company growing its bottom line in the double digits, and with that expected to continue for the foreseeable future, that sets up a situation where that’s kind of a baseline expectation for dividend growth.

Then you look at that very low payout ratio, which allows for dividend growth to exceed EPS growth for a rather long period of time.

I think the long-term will bear out a result pretty similar to this, even if there’s more growth on the back side.

The DDM analysis gives me a fair value of $138.27.

The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.

The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.

It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.

I find it to be a fairly accurate way to value dividend growth stocks.

Everything points to an undervalued high-quality dividend growth stock, but let’s compare my perspective and valuation to that of what two professional analysis firms have concluded.

This adds depth to our bottom line.

Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.

1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.

Morningstar rates DIS as a 4-star stock, with a fair value estimate of $130.00.

CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.

They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.

CFRA rates DIS as a 5-star “STRONG BUY”, with a 12-month target price of $130.00.

We can see a pretty heavy consensus across the board. Averaging the three numbers out gives us a final valuation of $132.76, which would indicate the stock is potentially 33% undervalued here.

Bottom line: Walt Disney Co. (DIS) is a media juggernaut with an unequaled collection of entertainment assets that are uniquely used to complement and add value to each other. Outstanding fundamentals, prospective future dividend growth at well into the double digits for years to come, and the possibility that shares are 33% undervalued means this is a very high-quality dividend growth stock that could entertain you and your portfolio with plenty of dividend income and capital gain for years to come.

-Jason Fieber

Note from DTA: How safe is DIS’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 99. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, DIS’s dividend appears very safe and extremely unlikely to be cut. Learn more about Dividend Safety Scores here.

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