One of the best ways to generate outsized returns in the stock market is by buying quality businesses at a good price and letting them compound over time. Investors will often go to great lengths to find a company that is unproven but has the potential to be a 10-bagger or better in the years to come. Yet often, the greatest investments lie hidden in plain sight.
One of my personal favorite examples is when Warren Buffett-led Berkshire Hathaway (BRK.A 0.92%) (BRK.B 1.24%) began buying Apple (AAPL -1.33%) stock in 2016. Apple was a powerhouse and a relatively obvious investment. Yet investors were selling the stock over fears that Apple wouldn't be able to grow both its services and hardware business and retain customers within its ecosystem. Boy, were they wrong.
Since Berkshire began buying Apple on May 16, 2016, Apple stock is up a staggering 644%. While I certainly don't expect Starbucks (SBUX 0.17%) or The Walt Disney Company (DIS -0.28%) stock to increase by more than sixfold in less than six years, I would say that both companies have strong brands and should be able to grow in the decades to come. Here's why.
Image source: The Walt Disney Company.
A beverage behemoth
If the market has taught us anything in the last few months, it's that valuation matters. And the charts indicate that Starbucks is a great value right now.
The company's price-to-earnings (P/E), price-to-sales, and price-to-free cash flow ratios are all currently below their five-year median ranges.
SBUX PE Ratio data by YCharts
Starbucks has rarely traded at a P/E ratio below 20 since going public nearly 30 years ago on June 26, 1992. In fact, the 10-year median P/E ratio between June 6, 1992 and June 6, 2002 was 163.9. In the following 10-year period, the median P/E ratio was 50.6. And today, the 10-year median P/E ratio is 31.5.
Granted, Starbucks is growing more slowly than it was in the past, so its P/E ratio deserves to compress. But given that its business is only beginning to turn the corner from its pandemic struggles, and is now faced with new headwinds, you could argue that earnings are a fraction of what they could be in the years to come.
One risk worth watching is Starbucks' pricing power. It remains to be seen where the line will be drawn in terms of Starbucks' ability to raise prices and pass the effects of inflation along to its customers. However, I would argue that Starbucks is using price hikes as a short-term solution to combat inflation.
Rather, most of the long-term growth is likely to come from grab-and-go ordering, smaller stores focused on pickup, and the classic drive-through model. That long runway paired with a stable and growing dividend makes for a compelling buy right now.
A media marvel
Disney doesn't have the low valuation that Starbucks has. In fact, the stock looks rather expensive on paper. But keep in mind that the House of Mouse is still recovering from the pandemic. COVID-19 cases are declining, which is great news. But we often forget that the situation was a lot worse just a few months ago. Disney lifted its mask mandate in February and still requires masks on public transportation.
The bear argument for Disney has some good points. Saturation in the streaming business, paired with a lack of commitment toward reinstating the dividend, isn't exactly a good look for a stock that used to cater toward risk-averse long-term investors.
However, if I could only buy and hold one stock for the next 20 years, Disney would be it. The park's business is back and could very well post record results this fiscal year. Disney+ complements Disney's studio entertainment segment. All told, Disney is becoming a stronger media company that can utilize more value from its content through theme park installations, merchandise, and other avenues than any other streaming businesses.
Disney should have no problem passing along higher costs to customers and combating inflation. The company said that per-capita spending was 40% higher in its fiscal 2022 first quarter than in the same period of 2019, indicating that customer demand is strong.
Picking Disney now may be an unpopular opinion. But the brand is too strong and the business has way too much growth potential to be valued lower now than when it first launched Disney+ in November 2019.
The fundamentals remain intact
Starbucks and Disney are two completely different businesses. But they both have strong brands and are leaders in their respective industries. The challenges Starbucks and Disney are facing do not seem to have to do with their core businesses -- which is great news for long-term investors.
When stocks go on sale for what seem to be short-term problems, it's almost always a great buying opportunity. Starbucks remains a beverage behemoth and Disney is a media marvel. Those positions don't seem to be changing anytime soon. If anything, they will probably only grow stronger in the decades to come.
