Disney: Valuation is Justified Due to High Business Predictability

Some may wince at The Walt Disney Company’s (DIS) forward PE ratio of 18.4 and avoid the stock because it trades higher than the S&P 500’s forward PE of 17. However, Disney is only trading 8.8% higher than the S&P 500 on a forward earnings basis. I think that Disney’s valuation is justified due to the company’s revenue and earnings growth consistency. This consistency gives the stock a high degree of predictability when looking forward. The consistency in revenue and earnings stems from Disney’s brand leadership in each segment.

Disney has increased revenue annually at single digit rates for at least the past five years. The company is expected to continue that growth for FY15 and FY16 according to analysts’ estimates. Even more impressive is Disney’s earnings growth which increased at an average annual rate of 18.8% for the past five years. Looking forward, analysts’ expect Disney to increase earnings at about 13% for both FY15 and FY16. Since the company typically exceeds its earnings estimates for most quarters, Disney could grow earnings at a slightly higher rate that what analysts’ are expecting.

Disney is valued about 8.8% higher than the S&P 500, but its earnings growth rate exceeds the market’s growth by a larger margin. For example, the S&P 500 is expected to average 8% annual earnings growth over the next five years, while Disney is expected to average about 16% annual earnings growth over the next five years. So, although Disney is only valued 8.8% higher than the S&P 500, the company’s earnings growth has the potential to approximately double the S&P 500’s earnings growth. Disney’s earnings growth is expected to be 100% higher than the earnings growth of the S&P 500. Even if Disney only achieves 10% annual earnings growth over the next five years, it would still be 25% higher than the S&P 500’s expected growth. Therefore, with Disney only valued 8.8% higher than the market, the stock still looks like a bargain.

When a company consistently achieves earnings growth that exceeds the broader market’s earnings growth, the stock typically outperforms the market. This is exactly what happened to Disney’s stock over the past five years. I would expect the same thing to continue as Disney continues to grow family oriented entertainment in all of its segments. The company’s consistency in growth leads to a high degree of predictability for the stock. Therefore, the higher than average valuation is justified because there is not much uncertainty to Disney’s core businesses.

Disney’s brand leadership is evident in the growth of its core businesses. There is plenty of advertising revenue strength in the broadcasting business with ABC and the Disney channel. Although ESPN showed some weakness last quarter, the company is confident that it will continue to grow over the long-term. ESPN is such a strong brand for sports fans that its continued growth is inevitable. There are repeating events such as March Madness, college football, fantasy football, baseball coverage, etc. that will have fans hooked for the future. This means that advertising revenue will always pour in.

The Parks and Resorts segment is likely to continue to grow as Disney’s parks, resorts, and cruises remain a top vacation choice for many young families. The Disney brand has been proven enough over time that parents have the confidence that the whole family will have a great time at the company’s destinations. To children, Disney vacations are like a ‘dream-come-true’ experience. Disney’s Parks and Resorts are likely to be enjoyed for future generations as well.

The company’s consumer products continue to show year-over-year revenue increases as Disney effectively ties in its entertainment characters to products that are demanded by children and their parents. Most children’s movies that Disney produces leads to sales of character-related items. This is a model that can easily be continued successfully. Little girls will never tire of wearing their favorite Disney princess dresses and the boys will never tire of having their own light saber battles while wearing Darth Vader masks.

So, to conclude, the company’s growth consistency for both revenue and earnings more than justify its slightly higher than average valuation. Disney is a brand that is likely to continue to live on for the long-term. Disney’s above average earnings growth is likely to lead to above average gains for the stock. I acknowledge that the stock currently looks temporarily overbought and due for a pullback. I also acknowledge that the stock is prone to sharp sell offs when the broader market sells off. However, my thesis for the stock is that it will continue to be a market outperformer over the long-term. This will be driven by consistent, above-average earnings growth, which leads to a high degree of predictability for stock growth.

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Strength Of Mark Zuckerberg’s Leadership And Vision Will Drive Facebook

Mark Zuckerberg successfully transformed Facebook (NASDAQ:FB) from a dorm room idea into the large publicly traded company that it is today. This took more than just luck. It took sophisticated technical skills, knowledge, strong leadership, visionary thinking, and persistence to pull off. Zuckerberg said this in January 2014 when he was reflecting back when the first version of Facebook was launched:

“I remember really vividly, you know, having pizza with my friends a day or two after — I opened up the first version of Facebook at the time I thought, You know, someone needs to build a service like this for the world. But I just never thought that we’d be the ones to help do it. And I think a lot of what it comes down to is we just cared more.”

That quote says a lot about Zuckerberg’s vision and his work ethic. He had the vision to see that Facebook could be used throughout the world and he had the skills and work ethic to persevere enough to make that a reality. Facebook’s ability to thrive as a growing company going forward will depend on how well Zuckerberg uses his skills, vision, and leadership to drive increased revenue and earnings for the company.

In addition to gauging Zuckerberg for his efforts to make Facebook a profitable company with over $11 billion in revenue and $2.75 billion in net income (for the past twelve months), we can also look at the decisions he made to grow the company. The decision to acquire Instagram, WhatsApp, Oculus VR, and PrivateCore is an example of Zuckerberg’s vision to allow Facebook to grow and evolve as a company.

The acquisitions of Instagram and WhatsApp act both to increase Facebook’s moat for its core business and to allow the company to grow additional revenue for the future. Oculus VR marked a foray into the world of virtual reality. Turning Oculus into a new revenue source may take some time to materialize, but the acquisition shows that Zuckerberg sees things beyond the core business of social media. Seeking Alpha author, Michael Slattery, did a great job of explaining the details of the potential for Oculus. Slattery shows that there are billions of potential revenue sources for Facebook through the Oculus technology. These acquisitions show that Zuckerberg has the vision to expand and grow the company and that he fully understands the potential for the Oculus technology. The Oculus acquisition also shows that Zuckerberg has a long-term time horizon as it may take a few years for the technology to produce revenue.

The acquisition of PrivateCore is to integrate its security technology into Facebook’s server stack to better protect its own servers and customers. PrivateCore’s technology will help protect Facebook from malware, unauthorized access, and other security threats. So, this acquisition will make Facebook more secure which is also likely to give its users more confidence in using the service. This move is a statement by Zuckerberg that shows that he is serious about the security of the site and also the security of its customers and users.

Advice from Steve Jobs

Zuckerberg stated that he was previously given advice from Steve Jobs. He said that Jobs advised him on how to sharpen his company’s focus and how to build the right management team. Jobs felt that it was his responsibility to give advice to up-and-coming technology executives before he passed away. However, it was Zuckerberg who sought the advice. Zuckerberg is likely to be considered another Steve Jobs or a Bill Gates. These are leaders that started a business from scratch, built them up to become world leaders in the technology industry, and had the vision and perseverance to allow the company to evolve and grow over decades. Zuckerberg demonstrates that he is in Facebook for the long haul. This is evident in his actions to build the company to where it is today and through the acquisitions that were made thus far. Zuckerberg also has a high degree of technical knowledge and skills which are traits that Steve Jobs and Bill Gates also demonstrated. Since Zuckerberg has some of the same traits as his technology predecessors, I think that he will lead Facebook to grow and thrive for decades.

The Bearish Argument for Facebook

Critics of Facebook are quick to point out that the company is just a fad. They point out that MySpace was once the leading social network site. The critics say that another website could come in and become more popular than Facebook. It is true that MySpace was the leading social network, up until April 2008, when Facebook replaced it as the site with the most unique worldwide visitors. However, I don’t think that this argument has much merit. MySpace was built on building an audience based on music and entertainment, while Facebook constantly launched new features that captivated a wider network of users. Facebook’s strategy goes back to how the business was led and managed. It was Zuckerberg who had the better understanding of what captivates users. MySpace also became slower and more difficult to use as it added more ads to its website. Zuckerberg, on the other hand led his team to introduce advertising to its site without causing too much disruption for its users. In a nutshell, Facebook gave users what they wanted in the form of a simple, easy-to-use platform, while MySpace tended to frustrate users.

All told, I think that Zuckerberg’s technical knowledge, vision, and leadership led to the success of Facebook as the leading social network site. If those who managed MySpace had the same overall characteristics, MySpace could have emerged as the leader. Facebook has accomplished more than MySpace ever did. MySpace never reached $1 billion in revenue, while Facebook is on track for over $12 billion in revenue for 2014 and $17 billion for 2015 according to analysts’ estimates.

Currently, there are no major threats in the form of competition for Facebook. Although it is possible for such a competitor to emerge, it would be rare for the leader of that competitor to match the vision, technical knowledge, perseverance, and leadership skills of Zuckerberg. As Facebook continues its success, it will be building up more cash. This will allow the company to make new acquisitions for new potential competitors.

Conclusion

While it can be useful to look at numbers to assess a company’s valuation and growth, it is also important to evaluate a company’s leadership. From what I’ve seen, Zuckerberg has what it takes to lead Facebook along a long-term evolutionary path of growth. Maybe another Zuckerberg will emerge in the future, but until then, Facebook is the leader in social networking and I will maintain my positive outlook for the company. All told, an investment in Facebook is an investment in advertising growth for over 864 million daily active users. The investment is also putting your trust into one of the greatest leaders of our time. With that in mind, I think that there is plenty of above average growth remaining for Facebook.

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Happy New Year 2015 !

Now that the new year has arrived, there are a few things to do:

1. Do everything a little better than you have before, incremental improvements can make a big difference.
2. Exercise regularly – this will keep you healthy and give you more energy in the long-run.
3. Build an emergency fund – This should be equal to 6 months of your take home salary. When the unexpected happens, you’ll have cash available when you need it.
4. Check your 401k or retirement plan investments. Ensure that you have a diverse allocation based on the amount of time remaining until retirement using an asset allocation calculator.
5. Start a 529 college savings plan for your children.
6. If you and your family are healthy, consider getting a high deductible health insurance plan and contribute to a health savings account (HSA). HSAs provide you with a triple tax benefit: the money goes into the account tax free, it grows tax free, and it comes out tax free when used for prescriptions, medical bills, and other health related expenses. The HSA account is owned by you and the money rolls over year-to-year. Some employers will match your contributions, adding to your savings.
7. Make a list of fun things you want to do this year and write them on your calendar.
8. Make a commitment to go to Church every week. You’ll start the week off right and it will allow you carry through the remainder of the week.
9. Try to make the world a better place by leaving things in better condition that you found them.
10. Contribute regularly to your favorite charity – you’ll be helping others who have a greater need than you do.

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Google Continues Innovating with Drone Delivery

* One of Google’s innovations is having drones deliver packages directly to homes.
* This shows Google’s commitment for continual innovation.
* In the meantime, the company is likely to perform well due to its advertising business.
* The stock remains fairly valued on a long-term earnings growth basis.

We have already heard that Amazon (AMZN) and Domino’s Pizza (DPZ) were testing the use of drones for delivering their products. Google (GOOG) (GOOGL) has recently announced that it is also testing the use of drones for delivery services. It is not clear if the Federal Aviation Administration (FAA) would ever approve of this or if all of the glitches would be worked out with such a system, but the technology does look interesting.

Google calls its drone efforts, Project Wing. The company reported that it used a 5-foot wide single-wing prototype to deliver candy bars, dog treats, water, cattle vaccines, and radios to two farmers in Queensland, Australia earlier this month. This video link shows the drone in action. Google did acknowledge that it would “take years to develop a service with multiple vehicles flying multiple deliveries per day.” The use of drones for delivery does raise a number of safety, logistical and liability issues. It does seem possible that this technology could be approved for use in less-populated, rural areas.

The effort to get drones into the delivery business is an example of Google’s commitment to innovation. Google is also working on a self-driving car, which I wrote about previously. These types of projects are more long-shot goals and will not have a material impact on the business any time soon if ever. However, they are interesting endeavors. So at the very least, the efforts should provide Google with plenty of positive publicity.

Where Google is innovating for the nearer-term in its core business is in internet search and discovery. Google is in the process of improving its app indexing. This involves improvements with allowing mobile users to more efficiently search and find what they are looking for. This includes allowing users to easily discover new apps and to create more engagement for users with apps that they haven’t used in a while. Google is also working on improving the user experience in switching from screen to screen on Android devices. The goal here is to improve the user experience by making switching from screen to screen as seamless as possible.

Advertising is what is currently driving Google’s success as it comprises 90% of total revenue. Although the company’s total revenue continues to grow, the rate of growth has declined in recent years. This was due to the advertising portion of the business maturing. The non-advertising portion of the business is growing at a faster rate than the advertising business. For example, for the first six months of 2014, advertising revenue increased by approximately 18% year-over-year, while non-advertising revenue increased by about 50% year-over-year. Since non-advertising revenue only comprises 10% of total revenue, the material impact on the company’s bottom line from this portion of the business is low. However, as the non-advertising business comprises more of the company’s total revenue over time, Google’s rate of growth is likely to benefit.

Since the advertising business is still increasing at double-digit growth rates, I think that stock will still perform well over the next few years. Google’s total revenue is expected to increase by 11.5% in 2014 and by 18% in 2015. Earnings are also expected to increase at healthy double-digits rates over the same time. Analysts are expecting a 20% increase in earnings for 2014 and a 19% increase for 2015. This is significantly higher than the expected annual earnings growth of the average S&P 500 company of about 10%. Google is fairly valued as its forward PE over its 5-year expected annual earnings growth rate is between one and two at 1.32. This is slightly below the Internet Information Providers industry PEG of 1.55 and slightly below the S&P 500’s PEG of 1.45. Given this fair valuation and above average earnings growth, I expect the stock to outperform the S&P 500 over the next few years.

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Who Wants to Be a Millionaire Investor?

Of course, just about everyone would like to be a millionaire investor. The ultimate investment goal of achieving financial independence where the level of wealth reaches a certain comfort zone is on the minds of many investors. What is the ideal way to achieve this? The majority of successful investors built wealth over time by dollar-cost averaging into stocks. This method takes the guesswork out of trying to time the market. In the end, short-term trading can be a zero-sum game as many gains are offset by the losses and the high-cost of commissions. It’s difficult for short-term traders to make the right call consistently. Using a 401k or similar plan to dollar-cost average is a great way to grow wealth over the long-haul. By putting an even amount of money into the market at regular intervals, investors can grow wealth tax free and not fret over the short-term market fluctuations.
The first step is to make a commitment to save a percentage of earnings. Investors should consider contributing the maximum amount allowed or at the very least, contribute the amount that would capture the entire company match. I would recommend a 10%-15% contribution for most individuals. By looking at a few examples, we can get a better picture of how to reach the $1 million milestone.

Example #1:
Let’s take a 25 year-old who is making $40,000 per year and contributing 10% of his salary to his 401k. Assuming that this individual does not yet have anything saved for retirement and that his employer contributes 1% of his salary to the plan annually with a 10% rate of return, he would reach $1 million at about age 57. After his entire career, this individual would have about $2.3 million at age 65.

Example #2:
Next, we have a 35 year-old woman who earns $45,000 per year and contributes 15% of her salary to her 401k. She already has $50,000 saved for retirement. Assuming a 10% rate of return, she would reach $1 million approximately at age 59. If her employer contributed 1% annually to her 401k, she would also have about $2.3 million at age 65.

Example #3:
We have a 55 year-old man who earns $75,000 per year and contributes 10% of his salary to his 401k. He has $200,000 saved for retirement. Assuming the same 10% rate of return, this individual wouldn’t reach $1 million until age 68. If his employer contributed 1% annually to his plan, this man would have about $682,000 at age 65.

These examples can be calculated at trend-chart.com and bankrate.com. These calculators are fun tools to play around with to figure out how much wealth you can acquire. Another important calculator, at bankrate.com, shows how much you’ll need at retirement. This is something that is important for everyone unless they are already independently wealthy.

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