Disney (NYSE:DIS) is having an amazing run: Shares of the House of Mickey Mouse are up by almost 40% in the last year, trading in the neighborhood of $110 per share -- not far from their all-time high. After such a whopping rise in a relatively short period of time, investors might think it's a good time to take some gains in Disney stock. But make no mistake: Disney still has plenty of gas left in the tank.
Behind the magic
Disney is one of a kind in the entertainment industry. The company has over the years consolidated a strong emotional bond with global consumers from different generations, and this gives Disney an irreplaceable source of competitive differentiation. Brand recognition, unique human talent, abundant financial resources to invest in production and marketing, and an invaluable portfolio of intellectual properties make Disney an undisputed leader in the business.
This fundamental quality has produced extraordinary financial performance for the company over the long term. The entertainment industry is particularly cyclical and dependent on consumer spending, but Disney is no average company, and key variables such as sales and earnings are clearly moving in the right direction.
Disney has an impressive track record of delivering sales and earnings results above Wall Street expectations, and the last quarter was no exception. It was a particularly challenging period for Disney, since the company faced remarkably tough year-over-year comparisons due to the massive success of Frozen stretching into 2014. However, Disney still delivered rock-solid performance, with sales growing by 7% and earnings per share increasing by 14%.
The future looks quite exciting, too. Avengers: Age of Ultron is off to an amazing start; the movie opened at No. 1 in every single market where it was released, and it has already brought in over $650 million in global box office. Disney will launch Star Wars: The Force Awakens on Dec. 18, and management could hardly be any more optimistic about this movie and its blockbuster potential. As CEO Bob Iger said in the latest earnings conference call:
The excitement around this movie is unlike anything we've ever seen before. The new trailer had more than 88 million views in the first 24 hours and now has more than 200 million views to date. So that gives you some sense of the tremendous interest and excitement around this film which should only intensify as we get closer to the Dec. 18 release date.
The company also plans to open its new Shanghai Disney Resort in spring 2016. The project, which has been under construction since 2011, will cover 963 acres, making it one of Disney's biggest projects ever. If things go as expected, Shanghai Disney could open the door for amazing growth opportunities in international markets in coming years.
On valuation and risk
Expectations are clearly quite demanding when it comes to Disney, and this is always a source of risk for investors. The company has not delivered earnings numbers below Wall Street expectations since the first quarter of 2011; while this is an amazing reflection on financial strength and consistency over time, it also means the bar is being raised for Disney, and chances are Wall Street will become excessively optimistic sooner or later.
Disney is also priced at a premium to the overall market. The stock trades at a price-to-earnings ratio above 24, while the S&P 500 index average offers a cheaper price-to-earnings ratio near 19.5.
Don't get me wrong, Disney can easily justify a superior valuation based on its fundamental quality and financial strengths. But the point is that, at current pricing, Disney stock is quite vulnerable to any disappointment down the road. Even if the business keeps firing on all cylinders, short-term price movements are always a matter of performance versus expectations, and expectations are clearly on the rise lately.
Still, this is no reason to sell. Trying to time a stock based on valuation can be remarkably difficult, if not downright impossible. Disney is a great business to own over the long term, ideally over decades to come if your time horizon is long enough. In case these demanding expectations produce any adjustments in the stock price, this should be interpreted as an opportunity to buy a world-class entertainment powerhouse at more convenient levels.
Make yourself comfortable, relax, and enjoy the show, because this amazing growth story is far from over.