Disney is a Story Worth Watching

The Walt Disney Company's (NYSE : DIS) stock has increased from $30 to $80 since July 2011, expanding its P/E multiple to 22. Despite this increase in valuation many on Wall Street believe the stock is certainly worth a look as it owns outstanding movie franchises like Monsters Inc. and Frozen. While these recent successes shouldn't be ignored Foolish investors interested in Disney should tread lightly given its rich pricing relative to competitors, obscure accounting methods, and large goodwill balance. 

Strong History
Disney has had some very strong movie brands over the years which include Toy Story, Finding Nemo, Pirates of the Caribbean, and National Treasure. The recent animated film Frozen recently broke $1 billion in sales and has out-grossed The Dark Knight and Jurassic Park. In the next few years, Disney is expected to release another National Treasure, Toy Story, and Pirates of the Caribbean. Even with powerhouse brands in the G-rated to PG 13-rated movies and 11 new titles coming out in 2014, Foolish investors should look past the box office success and analyze the underlying financials. In addition to this, there are few key accounting situations that are both unique to Disney and warrant closer inspection.

Revenue & expense recognition
Disney's method of recognizing revenue and costs are intricate. The accounting principles public corporations adhere to demand that revenues and expenses best match each other. The problem for Foolish investors is that revenues or expenses may be stretched out or dwindled down in ways that do not provide an accurate view of true operations. Disney's large revenue accounts are recognized as followed:

1. Revenues from theater distribution of motion pictures are recognized when exhibited.

2. Revenues from home entertainment and video game sales are recognized once made available for sale by retailers.

3. Revenues from the licensing of feature films and television programming are recorded when the content is available for telecast.

The above revenue items are complicated by how their respective costs are accounted for. The expenses are "estimated" by the product life cycle, based upon the ratio of the current period's revenues to the estimated remaining total revenues (Ultimate Revenues). Essentially, if Disney estimates an increase in Ultimate Revenues, it will report a lower cost for that period.

The significance of this is stated in Disney's 10K filing. "With respect to films intended for theatrical release, the most sensitive factor affecting our estimate of Ultimate Revenues is theatrical performance. Theatrical performance varies primarily based upon the public interest and demand for a particular film, the popularity of competing films at the time of release and the level of marketing effort."

While its reasonable to suspect that Disney has become good at estimating how a film or show may do, this is still a very uncertain discipline. Movies and shows that may expect large popularity could fizzle. There is a very real chance that Disney could be under reporting its costs, unintentionally or intentionally.

Goodwill & intangibles
Disney has a large amount of goodwill & intangible assets. These assets account for approximately 43% of total assets.

Goodwill & Intangibles

# in millions

2012

2013

Media Networks

17,854

17,782

Studio Entertainment

6,783

8,425

Other

5,488

8,487

Total

30,125

34,694

Source: Corporate SEC Filings

Disney's business model is highly involved within media and entertainment, so a high goodwill balance is expected. Time Warner (NYSE : TWX) and Twenty-First Century Fox, (NasdaqGS : FOXA) both have large balances of goodwill and intangibles relative to total assets.

FY 2013

TWX

FOXA

Goodwill

$30,563,000

$17,255,000

Intangible Assets

$9,549,000

$5,064,000

Total Assets

$67,994,000

$50,944,000

Source: Yahoo! Finance. Numbers are in thousands.

The large balances of goodwill and intangibles for these companies should keep Foolish investors on guard. The intellectual goodwill Disney has accumulated is valuable as long as the company can continue to generate revenues from those properties but should the day come when profits stop watch out.

 High P/E multiple
Disney's 22 P/E multiple is well above competitors Time Warner and Fox.

 

Disney

Time Warner

Fox

EPS (ttm):

3.64

3.92

2.14

P/E (ttm):

22.02

17.01

15.08

It is difficult to tell if the difference in P/E is warranted or not. Certainly the business of Disney is different than it's two peers. With that said, Disney's operating margin of 22% is between that of Time Warner's 23% and Fox's 17%. What this tells us is that while Disney owns some amazing media properties is overall profitability is not outstanding within the broader industry. 

Foolish Takeaway
Disney's stock is a precarious investment as it trades at a P/E multiple well above peers. While its movies may be worth watching, the large goodwill balance and expense recognition are something worth keeping an eye on as well. With the rich valuation, it may be best to sit on the sidelines as this story plays out.

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