This Dividend Growth Stock Appears 12% Undervalued: The Walt Disney Company (DIS)

Welcome back to the Valuation Zone.

So far this year, we’ve found 5 quality dividend growth stocks selling for >10% under their fair prices. In fact, I added one of them (Verizon) to my Dividend Growth Portfolio at about the same time that its article came out.

Stock Ticker Month Valuation Link to Article
PPL PPL May 15% under Link
Pfizer PFE April 13% under Link
Verizon VZ March 11% under Link
Omnicom OMC February 15% under Link
McKesson MCK January 19% under Link

This month, we’ll make it 6-for-6 with The Walt Disney Company (DIS).

Disney is a Dividend Challenger with an 8-year streak of increasing dividends.

It’s a low-yield, fast-growth stock.

Its current yield is 1.7%, while its 5-year dividend growth rate stands at 21% per year.

Disney last raised its dividend 7.7% in late 2017, payable in January 2018.

As always, before we take a look at a stock’s valuation, we’ll check to see if its dividend is safe.

Most dividend growth investors require a safe dividend before considering investing in a stock.

Disney’s Dividend Safety

For a complete discussion of dividend safety and reliability, see Dividend Growth Investing Lesson 17: Dividend Safety.

I use Simply Safe Dividends to assess dividend safety. They analyze cashflow, payout ratios, and several other metrics to arrive at an opinion about dividend safety. They summarize their results on this scale.

Here is how Simply Safe Dividends scores Disney:

You can’t get much better than that. Simply Safe Dividends’ score of 99 out of a possible 100 points places Disney just 1 point short of their maximum score. Disney’s dividend is safe.

Disney’s Valuation

To see how I value a stock, please read Dividend Growth Investing Lesson 11: Valuation. In a nutshell, I assess the stock in 4 different ways, then average the results out.

Step 1: FASTGraphs Default Valuation

In the the first step, we check the stock’s current price against FASTGraphs’ basic estimate of its fair value.

For its basic estimate, FASTGraphs compares the stock’s current price-to-earnings (P/E) ratio to the historical average P/E ratio of the whole stock market. That historical average is 15.

That P/E = 15 reference for fair value is shown by the orange line on the following graph, while the black line is Disney’s actual price.

Disney’s price is right on the orange line, suggesting fair valuation.

If you look close, there is a tiny difference. Disney’s current P/E is 15.1, while the orange line is drawn at 15.0. So actually Disney is a slight bit overvalued in this step.

To calculate the degree of overvaluation, we make a ratio out of the two lines.

Formula for Measuring Valuation on FASTGraphs
Actual P/E divided by Reference P/E
15.1 / 15 = 1.01

That translates to Disney being 1% overvalued.

Here’s how to calculate Disney’s fair price: Divide its actual price by that same ratio:

Formula for Calculating Fair Price
Actual Price divided by Valuation Ratio from above
$100 / 1.01 = $99

I round prices off to the nearest dollar, because I don’t want to create a false sense of precision. Valuing stocks is part art, part math. Different valuation methods will produce different results.

Step 2: FASTGraphs Normalized Valuation

The next step is to compare the stock’s current P/E ratio to its own long-term average P/E ratio. This lets us judge fair value by utilizing data on how the market has historically valued Disney itself rather than by how the market has valued all stocks.

I use the stock’s 5-year average P/E ratio (circled) for this step.

This 2nd step paints a different picture, because Disney has historically carried a higher P/E ratio of 18.3. So under this approach, Disney appears undervalued.

By how much? We use the same equations as in the first step.

The valuation ratio is 15.1 / 18.3 = 0.83. The stock appears 17% undervalued.

The fair price is $100 / 0.83 = $120.

Step 3: Morningstar Star Rating

The next step is to see how Morningstar values the stock.

Morningstar takes a different approach to valuation. They ignore P/E ratios.

Instead, they use a discounted cash flow (DCF) model. They discount all of the stock’s projected future cash flows back to the present to arrive at a fair value estimate. (If you would like to learn more about how DCF works, check out this excellent explanation at moneychimp.)

Under Morningstar’s 5-star system, 4 stars means that they think that Disney is undervalued.

This graph shows the last 5 years of Morningstar’s fair valuation estimates (red line) compared to Disney’s actual price (black marks).

As you can see, Morningstar calculates a fair price of $130. That means they consider Disney to be 23% undervalued.

Step 4: Current Yield vs. Historical Yield

The 4th and final valuation method is to compare the stock’s current yield to its historical yield. If a stock is yielding more than its historical average, that suggests that it is a better value than usual, because you are “paying less” for the stock’s dividends. It’s as if the dividends are on sale.

This display from Simply Safe Dividends shows Disney’s yield over the past 5 years and its current yield (the green dot).

Disney’s current yield of 1.7% is a little higher than its 5-year average yield of 1.6%. That suggests a slight undervaluation.

To calculate the degree of undervaluation, we form a ratio of the yields:

Formula for Measuring Valuation by Comparing Yields
Historical Yield divided by Current Yield
1.6% / 1.7% = 0.94

The fair price is computed using that Valuation Ratio the same way as in earlier steps. We get $100 / 0.94 = $106.

Disney’s Valuation Summary

Now we average the 4 approaches.

Notice that I colored both the FASTGraphs Default and Yield vs. Historical Yield results as yellow and called them “Fairly valued.”

That’s because I regard any price within +/- 10% of fair value to be a fair price. I do this, again, in recognition of the reality that valuations are assessments. They contain some elements of subjectivity and reasonable estimates.

The average of the 4 fair-price estimates is $114, compared to Disney’s’s actual price of about $100. That’s a 12% discount to fair value, suggesting a nice margin of safety for someone buying the stock now.

Closing Thoughts

I never suggest that anyone should take action based solely on one of my articles or to mimic what I own. A fuller analysis would be required.

Therefore, this is not a recommendation to buy Disney. Perform your own due diligence. Check the company’s dividend record, business model, quality, financial situation, and prospects for the future.

Also consider whether it fits (or does not fit) your long-term investing goals. In Disney’s case, low yield combined with fast dividend growth is not what everybody is looking for.

— Dave Van Knapp

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