Walt Disney´s Dividend Hike Seems to Adequate to Its Intrinsic Value

In this article, let's take a look at The Walt Disney Company (DIS, Financial), a $159.52 billion market cap company, which is a media and entertainment conglomerate which has diversified global operations intheme parks, filmed entertainment, television broadcasting and consumer products.

Dividend Hike

A few days ago, the board of directors approved a 33.7% increase in its annual dividend to 1.15 from its previous 85 cents. Based on that, shares rose and closed at a record high of $93.81. The current dividend yield is 1.20%, with an annual payout of $1.15. The 5-year dividend growth rate of the firm is 27.5% and is ranked higher than 90% of the of the 136 Companies in the Media - Diversified industry.

Growth of 10,000

If you had invested $10.000 five years ago, today you could have $33.282, which represents a 27.2% compound annual growth rate (CAGR).

Price Performance

The company´s shares have climbed about 30% over the past year, rising more than twice than the Standard & Poor’s 500.

Revenues

Looking at profitability, revenues increased by 7.09% and led earnings per share increased in the most recent quarter compared to the same quarter a year ago ($0.86vs $0.77).During the past fiscal year, the company increased its bottom line. It earned $4.25 versus $3.38 in the prior year. This year, Wall Street expects animprovement in earnings ($4.65 versus $4.25)

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 22.1x, trading at a discount compared to an average of 42.9x for the industry. To use another metric, its price-to-sales ratio of 3.39x is above the industry average of 2.22x.

Absolute Valuation

In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends according to John Burr Williams.

Although this is theoretically correct, it requires forecasting dividends for many periods, so we can use some growth models like: Gordon (constant) growth model, the Two or Three stage growth model or the H-Model (which is a special case of a two-stage model).With the appropriate model, we can forecast dividends up to the end of the investment horizon where we no longer have confidence in the forecasts and then forecast a terminal value based on some other method, such as a multiple of book value or earnings.

To start with, the Gordon Growth Model (GGM) assumes that dividends increase at a constant rate indefinitely.

This formula condenses to: V0=(D0 (1+g))/(r-g)=D1/(r-g)

where:

V0 = fundamental value

D0 = last year dividends per share of Exxon's common stock

r = required rate of return on the common stock

g = dividend growth rate

Let´s estimate the inputs for modeling:

Required Rate of Return (r)

The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stockj = risk-free rate + beta of j x equity risk premium

Assumptions:

Risk-Free Rate: Rate of return on LT Government Debt: RF = 2.67%. This is a very low rate because of today´s context. Since 1900, yields have ranged from a little less than 2% to 15%; with an average rate of 4.9%. So I think it is more appropriate to use this rate.

Beta: β =0.96

GGM equity risk premium = (1-year forecasted dividend yield on market index) +(consensus long-term earnings growth rate) – (long-term government bond yield) = 2.13% + 11.97% - 2.67% = 11.43%[1]

rDIS = RF + βDIS [GGM ERP]

= 4.9% + 0.96 [11.43%]

= 15.87%

Dividend growth rate (g)

The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm´s debt-to-equity ratio is unchanged and it doesn´t issue new equity.

g = b x ROE

b = retention rate

ROE=(Net Income)/Equity= ((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)

The “PRAT” Model:

g= ((Net Income-Dividends)/(Net Income)).((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)

Let´s collect the information we need to get the dividend growth rate:

Because for most companies, the GGM is unrealistic, let´s consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage, until it reverts to the long-run rate. A smoother transition to the mature phase growth rate that is more realistic.

Dividend growth rate (g) implied by Gordon growth model (long-run rate)

With the GGM formula and simple math:

g = (P0.r - D0)/(P0+D0)

= ($93.97 ×15.87% – $1.15) ÷ ($93.97 + $1.15) = 14.47%.

The growth rates are:

G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).

Calculation of Intrinsic Value

Final Comment

We have covered just one valuation method and investors should not be relied on alone in order to determine a fair (over/under) value for a potential investment.

Trading nearly the 52-week high seems to be announcing a fall in price. However, we think that it is the right time to add the stock to your long-term portfolio.

Hedge fund gurus like Ruane Cunniff (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), Mario Gabelli (Trades, Portfolio), Tom Gayner (Trades, Portfolio) and the funds Dodge & Cox and Pioneer Investments (Trades, Portfolio), added the stock in the third quarter of 2014.

Disclosure: Omar Venerio holds no position in any stocks mentioned.

[1] This values where obtained from Blommberg´s CRP function.

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