Free 7-day Trial
All Articles and Columns »

Set Your Sights High in the Sky with DirecTV

April 25, 2012 | About:
Although DirecTV (DTV) may not be the most conservative stock you could ever review, it is clearly a consistent and fast grower. Moreover, even though it is a favorite of legendary investors like George Soros, Warren Buffett and others, DIRECTV is currently being valued at below market valuations. Consequently, the opportunity DIRECTV offers to invest in very high growth at below-average valuation is rare and should at least be given a serious look.

Growth stocks are defined as companies with high rates of change of earnings growth of 15% to 20% or better. Growth stocks offer the potential for share prices to rise in lockstep with their profit growth in the long run. Therefore, the PEG ratio formula (price equals growth rate) tends to be the most appropriate formula used to value growth stocks. However, due to the exponential nature of compounding large numbers, PEG ratio forecasts are capped at 40%.

Because of the higher valuation typically awarded to fast growth, growth stocks offer the potential for greater capital appreciation. On the other hand, they also offer higher risk. First of all, they tend to command much higher than average PE ratios, and second, achieving very high levels of growth is very difficult to sustain. Consequently, forecasting future earnings growth is more important with high growth stocks than any other class of stock. Also, the average growth stock typically ploughs all of its profits back into the company to fund its future growth, instead of paying dividends.

DirecTV (DTV): Large-cap Growth at an Attractive Price

About DirecTV: Directly from their website

“DIRECTV (DTV) is one of the world's leading providers of digital television entertainment services. Through its subsidiaries and affiliated companies in the United States, Brazil, Mexico and other countries in Latin America, DIRECTV provides digital television service to 19.9 million customers in the United States and over 12 million customers in Latin America. DIRECTV sports and entertainment properties include three regional sports networks (Northwest, Rocky Mountain and Pittsburgh) as well as a 60 percent ownership interest in Game Show Network.”

DTV-1.png

Earnings Determine Market Price: The following earnings and price correlated F.A.S.T. Graphs™ clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.

Here is a link to a live and fully functioning graph on DIRECTV. We suggest running graphs over numerous time frames as part of a more comprehensive fundamental analysis.

DirecTV: Historical Earnings, Price, Dividends and Normal PE Since 2007.

Performance Table DirecTV

The Two Keys to Long-Term Performance

Years of research and experience have taught us that there are two critically important keys to achieving above-average, long-term shareholder returns at reasonably controlled levels of risk. The first key is earnings growth, or what we like to call the rate of change of earnings growth. The faster a company can grow its business (i.e. earnings), the larger the income stream it can produce with which to reward shareholders. This is because of the power of compounding, which Albert Einstein was alleged to have called "the most powerful force on earth." Ultimately, both capital appreciation and dividend income will be a function of a company's ability to grow its profits.

The second key is valuation. When a company can be purchased at its intrinsic value based on earnings and cash flow generation, the shareholders' rate of return or long-term capital appreciation will inevitably correlate to and/or equal its earnings growth rate. Overvaluation will lower that rate of return and conversely, undervaluation will increase it. Consequently, paying strict attention to the valuation you pay to buy a stock is a critical component of both greater return and taking lower risk to achieve it. Because, ironically, when you overpay for even the best business, you simultaneously lower your return potential while increasing your risk of achieving the lower return.

The associated performance results with the earnings and price correlated graph, validates the above discussion regarding the two keys to long-term performance. Notice the impact that valuation (black line above or below orange earnings justified valuation line) had on the following performance results.

DTV-2.png

The following graph plots the historically normal PE ratio (the dark blue line) correlated with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as low as it has been since 2007.

DTV-3.png

A further indication of valuation can be seen by examining a company’s current price to sales ratio relative to its historical price to sales ratio. The current price to sales ratio for DirecTV is 1.20 which is historically low.

DTV-4.png

Looking to the Future

Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:

1. The rate of change (growth rate) of the company’s earnings

2. The price or valuation you pay to buy those earnings

Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound and profitable performance.

Therefore, it logically follows that measuring performance without simultaneously measuring valuation is a job half done. DirecTV is clearly an industry leading superior business, which based on the consensus estimates from leading analysts, appears to be capable of growing earnings at an above-average rate for the foreseeable future. At its current price, which is attractively aligned with its True Worth™ valuation, DirecTV represents an opportunity for growth at a reasonable price. The important factor is that DirecTV, with its strong balance sheet and potential for future earnings growth, has real assets and cash flow underpinning its stock price. This solid economic foundation offers shareholders the potential for both a strong margin of safety and an opportunity for outsized future returns.

The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.

The consensus of 21 leading analysts reporting to Capital IQ forecast DirecTV’s long-term earnings growth at 18.8%. DirecTV has high long-term debt at 127% of capital. DirecTV is currently trading at a P/E of 12.6, which is below the value corridor (defined by the five orange lines) of a maximum P/E of 22.6. If the earnings materialize as forecast, DirecTV’s True Worth™ valuation would be 199.22 at the end of 2017, which would be a 28.7 annual rate of return from the current price.

DTV-5.png

Earnings Yield Estimates

Discounted Future Cash Flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stake holders over time. Therefore, because Earnings Determine Market Price in the long run, we expect the future earnings of a company to justify the price we pay.

Since all investments potentially compete with all other investments, it is useful to compare investing in any perspective company to that of a comparable investment in low risk Treasury bonds. Comparing an investment in DirecTV to an equal investment in 10year Treasury bonds, illustrates that DIRECTV’s expected earnings would be 11.9 times that of the 10year T-Bond Interest (see EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.

DTV-6.png

Summary and Conclusions

This report presented essential “fundamentals at a glance” illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although with just a quick glance you can know a lot about the company, it’s imperative that the reader conducts their own due diligence in order to validate whether the consensus estimates seem reasonable or not.

DirecTV is a very fast-growing business that looks to offer the aggressive investor interested in maximum capital appreciation a rare opportunity to invest in high growth at a reasonable price. Debt levels are a concern; however, the company is a very strong generator of free cash flow and appears capable of handling its debt load comfortably. Nevertheless, we feel that only the most risk tolerant investor consider this high growth opportunity. On the other hand, current low valuation does mitigate risk, in our opinion. As always, we recommend you conduct your own due diligence.

Disclosure: No position at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation. A comprehensive due diligence effort is recommended.

About the author:

FAST Graphs
F.A.S.T. Graphs™ is a powerful research tool providing "essential fundamentals at a glance" on over 17,000 symbols. F.A.S.T. Graphs™ empowers the user to research stocks deeper and faster by allowing them to exploit the undeniable relationship and functional correlation between long-term earnings growth and market price. Warren Buffett, the greatest capital allocator of all time, said; "there are only two things that investor needs to know; how to value a company and how to think about stock prices." With the F.A.S.T. Graphs™ at their disposal, users are able to perform both of these critical tasks... FAST.

F.A.S.T. is an acronym for Fundamentals Analyzer Software Tool that takes all the hours of manual graphing of business fundamentals and reduces it to seconds, giving you critical information in an instant. With one glance you know a lot about the business you are graphing and its past, present and future value. F.A.S.T. Graphs™ should be the first step in every research project. Each graph is worth 1,000 words in describing a company's growth, consistency and valuation.

Visit FAST Graphs's Website


Rating: 4.1/5 (8 votes)

Comments

vgm
Vgm - 1 year ago
I don't know how many times it has to be repeated: DTV is NOT a Buffett pick. It was Ted Weschler (and possible Todd Combs also) who bought DTV for Berkshire!!

Weschler had owned it previously at his former hedge fund.

The interesting thing to me is that, at around $750M, it represented a very substantial percentage of their total allocation (I recall Buffett saying they each had about $1.75B), reflecting a high confidence level in the stock.
vgm
Vgm - 1 year ago
Brief but quite interesting piece from Forbes: Why DirecTV Could Double

http://www.forbes.com/sites/kenkam/2012/04/30/why-directv-could-double/?partner=yahootix

Disclosure: long DTV

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK
Hide