Disney (DIS 3.69%) stock has delivered lackluster returns lately. Shares of the entertainment powerhouse are down by 20% from their highs of the last year, mostly because of concerns about the negative impact the online streaming revolution could have on the company's business. Nevertheless, when considering variables such as business quality, financial performance, and valuation, there are strong reasons to believe that the short-term dip in Disney could present a buying opportunity for long-term investors.
A world-class business
Disney is a unique company in the entertainment industry, as it benefits from expectational fundamental strengths. The company owns enormously valuable brands such as Disney itself, Pixar, ESPN, Marvel, and ABC, among others. In addition, it has the intellectual rights to many of the most valuable fictional characters and franchises in the world, ranging from Mickey Mouse to Star Wars. In case this weren't enough, unparalleled human talent and abundant financial resources to invest in areas such as movie productions and advertising provide additional layers of strength for the business.
The industry is permanently evolving, and Disney needs to adapt to changing consumer demand. The cord-cutting revolution is here to stay, as consumers around the world are increasingly moving away from traditional cable toward streaming services such as Netflix (NFLX 5.03%). Based on financial reports for the fourth quarter of 2015, Netflix has a gargantuan user base of almost 75 million members around the world, and management is expecting to add over 6 million new members in the first quarter of 2016.
On the other hand, content is king in the business, and a content powerhouse such as Disney can find the right venues to continue thriving in an always dynamic environment. In fact, Disney and Netflix can be considered competitors in some way, but they're also partners to a good degree. In 2012 Netflix and Disney made an agreement that gives Netflix the exclusive rights for all new Disney releases once they leave theaters, including the Disney back catalog, starting in 2016.
Distribution channels and consumer habits will most probably continue to evolve in the future, but Disney is still one of the strongest companies in the entertainment industry. As long as Disney keeps producing highly demanded content for a wide audience, technological change is no reason to fear. On the contrary, chances are that Disney will find the right way to leverage technology and make both customers and investors happy over the long term.
Spectacular financial performance
The business is clearly firing on all cylinders, and Disney has recently announced record sales and earnings for the quarter ended on Jan. 2 on the back of extraordinary success from Star Wars: The Force Awakens.
Total revenue grew 14% year over year to $15.2 billion, segment operating income increased 20% versus the same quarter in the prior year, and diluted earnings per share jumped by a staggering 36% to $1.73 per share. This was a historical record for Disney in terms of earnings, and also the 10th consecutive quarter in which the company delivered double-digits earnings-per-share growth.
The studio division was the main driver for Disney last quarter. Total revenue in this segment grew 46%, while operating income increased 86% year-over-year. The enormous success of Star Wars: The Force Awakens will be hard to repeat; however, Zootopia has topped box-office receipts over the past three weeks in a row, so Disney keeps proving to investors that it has a fairly exceptional ability to deliver consistently successful movie productions in a recurrent way.
Even the best companies can be mediocre investments when valuation is excessively optimistic; however, that's hardly the case when it comes to Disney stock nowadays. According to data from Morningstar, Disney is trading at a forward price-to-earnings ratio in the neighborhood of 15.4, a small discount versus the average company in the S&P 500 index, which trades at a forward price-to-earnings in the area of 16.8.
Considering Disney is a top-notch business generating rock-solid financial performance, the company could easily justify an above-average valuation. Fortunately for investors in Disney, this means the stock offers substantial room for gains from current valuation levels.