This Just In: Upgrades and Downgrades

Over the next 12 months, Walt Disney (DIS -1.36%) plans to release nine separate major motion pictures, including near-certain smash hits like Star Wars: The Force Awakens, Captain America: Civil War, and Finding Dory. With so much buzz behind the film slate, it can be hard for Wall Street analysts to resist the pressure to wax enthusiastic about the stock.

One such analyst, NYC's  Cowen & Co., finally bowed to that pressure this morning, and upped its price target on Disney -- but it did so under duress.

Why so glum, chum?
Announcing its decision to raise its price target on Disney stock, Cowen took the very modest step of adding only $3 to its valuation of the company -- and now prices the stock at $92. Astute observers will notice, however, that this target is still nearly $28 below where Disney stock trades today ...

So what's the reason for Cowen's reluctance to endorse Disney? According to the analyst, "the market is valuing Disney's non-TV businesses at somewhere between a 23x and 30x implied P/E ratio. While we agree that Disney has the best collection of film IP, this seems to us to be a very high valuation ..."

And indeed it is. Disney's biggest rivals in the movie business, companies such as Twenty-First Century Fox and Time Warner, sell for far lower valuations relative to their earnings. Time Warner shares, for example, can be had for less than 16 times earnings today. Twenty-First Century Fox costs less than 8 times earnings!

But does the fact that its competitors cost less mean that Disney shares should also decline? Should they decline as much as the 23% collapse in share price that Cowen & Co. is predicting?

Let's go to the tape
Maybe it does, and maybe they should. After all, Cowen & Co. has a pretty good record in this business. Out of its six active recommendations in the media industry today, four are currently outperforming the market -- and these include Cowen's recommendations to buy both Twenty-First Century Fox and Time Warner:

What's more, when Cowen says Disney shares are overpriced, it's not just referring to the shares' price relative to the valuations on Disney's competitors. Viewed all on its own, Disney stock looks objectively overvalued as well.

How much is Disney stock worth?
According to the analysts who follow it, even if you assume a financial boost from the nine films coming out over the next 12 months, analysts still only see Disney's total corporate profits growing about 12% annually over the next five years. That's not a particularly fast growth rate to support a stock selling for more than 24 times earnings, as Disney does.

And let's not forget -- valuing Disney on GAAP earnings alone gives the stock a huge benefit of the doubt. It gives a lot of credence to the company's GAAP income statement, which claims $8.4 billion as "net income" earned over the past year. In fact, though, Disney's free cash flow for the past 12 months has amounted to just $6.6 billion -- less than 80% of reported net income.

Value Disney on its actual cash profits, though, and the stock is selling for not "24 times earnings" but more than 30 times free cash flow. (And it's even more expensive once debt is factored into the picture. The company's enterprise value-to-free-cash-flow ratio is a whopping 32.9).

The upshot for investors
Despite its sky-high valuation, Disney remains an exceedingly popular stock among both professional analysts, and amateur investors alike. On Motley Fool CAPS, Disney shares retain a sterling "five-star" rating, the highest compliment our CAPS members can give a stock.

This doesn't mean that Cowen is wrong to question Disney's worth -- but it does explain why the analyst may have felt compelled to raise its price target on a stock that it clearly is not at all enthusiastic about. Pointing out the overvaluation of a popular stock cannot be a pleasant experience for Cowen -- but when Disney stock does finally stumble, its the investors who will the real pain.