Source: PaxForex Premium Analytics Portal, Fundamental Insight
Calculating risk and the potential reward is a fundamental requirement for any kind of investment. Companies do it all the time before building a new factory, opening a new store, or investing in research and development. But when it comes to an individual company, determining risk and the potential reward is one of the most difficult and abstract concepts.
Some investors try to use discounted cash flow models to forecast future cash flows and then discount them to account for the time value of money. Others use financial measures such as price-to-earnings (P/E) ratios to decide whether a stock is undervalued or overvalued.
Today, we will take a more conversational approach to the risk/reward ratio and look at Walt Disney stock over the ultra-long term and why it is a good value right now.
For a number of reasons, Disney stock is down about 45% from its all-time high. For starters, the negative effects of the coronavirus pandemic persist. In addition, there are fears that the recession will lead to lower consumer spending, which means fewer people going to theaters and parks. Disney+ continues to lose money. And since Netflix reported a dire quarter, it calls into question the long-term viability of the Disney+ streaming service. Disney's stance on political issues in Florida has been controversial and has not been good for the company's stock. Finally, market volatility, in general, has put pressure on Disney stock.
The good news is that the only real long-term obstacle affecting Disney is Disney+ profitability. The other issues are relevant, but they are likely to be only short- to medium-term.
There is every argument to think that all other aspects of Disney's business will soon return to 2019 and 2018 levels and set new records in the years ahead. Let's not forget Disney's box office success, which was breaking records in 2019 before the pandemic. Disney generated $3.747 billion in gross box office revenue in 2019, adjusted for inflation, which was 33% of the total movie box office market share. Overall, Disney had record revenues of $69.61 billion in fiscal 2019 and record profits of $12.60 billion in fiscal 2018.
It seems likely that Disney+ will end up being a net positive for the company in the long run, especially given its growth to date and how well it integrates with the parks and movie business. But for now, even with the addition of Disney+, Disney as a whole is priced lower than it was before the pandemic.
Unlike Disney Movies, which is still in recovery, Disney Parks is already showing that it is close to its pre-pandemic form. In the first quarter of the fiscal year 2022, per capita spending at the national parks was up 40% over the first quarter of the fiscal year 2019, helping Disney generate 95% more revenue in the holiday quarter of the calendar year 2021 than in the holiday quarter of the calendar year 2019.
Even with increased investment in Disney+, Disney continues to invest in its parks, opening Star Wars: Battlestar Galactica and Guardians of the Galaxy: Cosmic Rewind in March, a highly anticipated attraction that will open at EPCOT on May 27.
Parks, media, and entertainment studios are the lifeblood of Disney. Disney typically generates operating profits of more than 20 percent from its parks, which can be used to reinvest in parks or other long-term projects such as Disney+.
Disney stock's lowest point of decline in seven years was on March 18, 2020, when it hit $79.07 per share. That was when the S&P 500 was down more than 30 percent, the fear surrounding COVID-19 was growing, uncertainty was high, and no one knew how serious the pandemic was or how long it would last. Disney+ was launched in less than six months and had yet to establish itself.
All shares could fall as low as $0. But this $79 per share mark provides a reasonable bottom for Disney stock. It is about 30% below the current stock price. Nevertheless, the all-time high for Disney was $203.02 per share on March 8, 2021. That high came when optimism about Disney+ was strong and there was confidence that the parks and movie business would recover. It seems more likely that optimism about Disney will return to 2019 levels sometime in the next five years than pessimism will reach its maximum fear index during a pandemic. For that reason alone, Disney's risk/reward profile is incredibly attractive.
Let's take it one step further. If you believe that the company will ultimately beat its record profits from parks and movies and that Disney+ will one day reach profitability, then the stock could rise well above its previous all-time high -- which is a much bigger reward than the risk that it will fall back to the peak panic level of $79 a share or so. So the upside potential is over 100%, but I believe the downside potential is only about 30%. This suggests that Disney has an attractive risk/reward profile, but only because record profits are still ahead and the company's best days are ahead, not behind.
To further bolster the valuation argument, consider that Disney's record net income in 2018 was $12.6 billion. If the company were to reach that level of net income now, its P/E ratio would be 16.4. However, this is unrealistic because Disney is spending a lot of money on Disney+, which again is not yet profitable. Even so, according to the consensus analyst forecast, Disney will earn $5.40 earnings per share in 2023, giving it a 2023 P/E ratio of about 21 -- not cheap, given that Disney is still not even close to a potential profit margin for Disney+.
Buying during a bear market is never easy. It's hard to be sure to buy when the stock seems to be setting new lows every week. However, for a company like Disney, which is one of the most powerful brands in the world and has huge growth potential, the risk/reward ratio is unbelievably attractive.
As long as the price is below 128.00, follow the recommendations below::
- Time frame: D1
- Recommendation: short position
- Entry point: 107.12
- Take Profit 1: 100.00
- Take Profit 2: 90.00
Alternative scenario:
If the level of 128.00 is broken-out, follow the recommendations below::
- Time frame: D1
- Recommendation: long position
- Entry point: 128.00
- Take Profit 1: 144.00
- Take Profit 2: 156.00
