Is Disney a Value Trap?

For value investors, few stock market situations are more troublesome than value traps, which describe stocks that appear to be trading at steep discounts to their intrinsic values because of deteriorating conditions in the underlying businesses. As such, value traps can easily leave value investors with significant losses.

One stock that has recently drawn attention as a possible value trap is entertainment behemoth Disney (NYSE:DIS). Down 19 percent in the past year, Disney has struggled to regain the earnings it enjoyed post the Great Recession. 

The question is whether the selloff has provided an opportunity or created a value trap?

How Do You Tell if a Stock Is a Value Trap?

One common indication of a value trap is a significant reduction in valuation multiples relative to historical averages.

A stock that sees its P/E ratio drop from an average of 15 to 8, for example, could be a value trap. This is especially true if the company’s competitors maintain or increase their multiples during the same period.

Similarly, a marked decrease in earnings over a sustained period of time could indicate a value trap.

It’s important to note, however, that the market can and frequently does value stocks incorrectly. In fact, this fact is what allows value investors to occasionally buy stocks at deep discounts due to market volatility.

As such, it’s important to carefully analyze the fundamentals and competitive advantages of a company to determine if it could be a value trap.

Is Disney a Value Trap?

Looking at the decline in Disney earnings over the past few years, the company does show signs of being a value trap.

For the full year of 2019, Disney earned $5.94 per share. During the 12-month period ending on June 30th, 2023, the company’s EPS was just $1.23.

It’s interesting to note, however, that Disney’s P/E ratio has not collapsed. In fact, the trailing 12-month P/E ratio at the time of this writing was a rather high 67.7.

Turning to the most recent earnings report, there are further signs that could support the value trap argument.

Adjusted EPS for the quarter was $1.03, down from $1.09 in the year-ago quarter. Revenue, meanwhile, rose just 4 percent year-over-year. It should be noted that the company’s free cash flow skyrocketed during the same period, rising from $187 million a year ago to $1.64 billion.

Analysts Forecast Disney Earnings Will Rise

Most analysts, however, still believe that Disney can improve its earnings over the next few years.

By Q1 of 2025, the analysts’ consensus forecast suggests that Disney will earn $1.40 per share. On the 5-year horizon, Disney’s earnings per share are expected to increase at a compounded annual rate of 21.5 percent.

While analysts’ projections are far from guaranteed, the consensus expectation of much higher earnings from a company that is widely covered provides another indication that Disney could be legitimately undervalued.

Much of this expected increase in earnings will be from the new cost savings program introduced by returning CEO Bob Iger. The leadership team expects  to pare expenses by as much as $5.5 billion while also increasing its operating income from the direct-to-consumer segment by as much as $1 billion.

These efforts have, however, temporarily added significant restructuring costs to the company’s overall expenses. In the most recent quarter, Disney spent $2.65 billion on restructuring, up from just $42 million a year ago.

Disney also maintains strong competitive positions in many of its key business areas. Even with a recent string of rocky box office performances, Disney still accounted for 26 percent of all box office revenues in the US and Canada in 2022. Plus, it remains among the top five streaming services, though it should be noted that its 13 percent market share is significantly outpaced by market leader Amazon’s 21 percent.

Is Disney Over or Undervalued?

With earnings expected to grow at fairly rapid rates over multiple years, institutional ownership still exceeding 60 percent and a strong competitive position in its key industries, Disney seems to be undervalued.

This view is supported by the stock’s forward P/E ratio of 22.8, which is a reasonable multiple in the current market environment.

General Wall Street’s bullishness is also reflected in analysts coverage of Disney. Of the 34 analysts who have rated the stock, 22 maintain a Buy rating.

Meanwhile, only two have rated Disney as a Sell. Turning to price forecasts, the median 12-month price target for Disney is $109.45, implying a potential upside of 32.5 percent.

Is Disney Worth Investing In?

Although Disney has gone through a difficult period, the stock could be a good choice for long-term value investors.

It’s important to understand, though, that Disney shares could still fall on the basis of weaker-than-expected short-term performance.

Given that the company appears set to remain a powerful force in the entertainment industry and regain at least some of its former earning power, Disney still appears to be a potentially worthwhile investment.

Is Disney a Good Long-term Buy?

Because it’s starting from a relatively low baseline, Disney could take several years to have a chance of mounting a full recovery.

As such, Disney is likely best for investors with a fairly long time horizon and who are willing to hold through periods of elevated volatility.

A 10 year discounted cash flow forecast analysis places fair value for Disney at $121 per share, so Disney appears to be a good long-term buy.

How Do You Avoid Value Traps in Stocks?

One of the best ways to avoid value traps is to look for companies with a significant economic or competitive advantage. These businesses, often described as having moats, are somewhat less likely to be value traps due to their dominant positions within their industries.

Another key factor to examine is the company’s balance sheet, as value traps may carry unsustainable levels of debt.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.