When I first wrote about Disney’s risk related to ESPN subscriber loss about a month or so ago, I meant to write an immediate follow-up post that discussed three factors that makes Disney a good case study right now for studying the psychological factors that affect people’s investment perceptions: (1) headline risk, (2) groupthink, and (3) the tendency to “secure” quick short-term gains at the risk of making substantially more money over a 20+ year holding period.
Before we talk about headline risk, you should pause and read this excellent piece by Maria Konnikova in the December 2014 New Yorker titled “How Headlines Change The Way Think” that discusses some University of Western Australia studies on how the specific headlines we encounter has a disproportionate impact on the conclusions that we draw from reading the articles. Although there have been a decent amount of Star Wars articles written about Disney lately, much of the investment commentary since this summer has focused on the subscriber loss stemming from ESPN.
That does create a real bias that can affect your understanding of reality if you’re not careful–Disney isn’t just theme parks, but a TV channel, a cruiseline, a toy factory, Winnie The Pooh, Pixar, ABC Studios, Marvel Comics, Pixar, and LucasFilm Studios. ABC and ESPN contribute 43% to revenues; the parks, resorts, and cruise-lines contribute 31% to revenues; the movie studies contribute 15%; and the rest come from consumer products, Tokyo Disneyland royalties, Hong Kong Disneyland, and Disneyland Paris.
This means that the articles you read about Disney which are critical of ESPN’s growth could be correct, but the expected inference “Therefore, Disney stock should be avoided” may be incorrect. What the headlines discount is this: even including subscriber loss at ESPN, Disney is expected to grow earnings per share from $4.26 in 2014 to $5.05 in 2015. The earnings growth is 18.5% for this “struggling” period, a number that is both superior and generally in line with the ten-year annual earnings per share growth rate of 16.5%. The headlines identifying the risks to the business model misstate the totality of the situation, as the enterprise results collectively are far superior to one sub-aspect of the business that is frequently discussed.
The second and third aspects are related, as groupthink informs people to sell their stock. Most message board activity involves people saying that they are selling their stock, and then people look at the quick gain they have received and seek to realize their profit. Considering that Disney stock sold at $15 in 2009, there have been many opportunities to lock in a quick profit from the holding in the past six years. It hit a high of $38 in 2010, $44 in 2011, $53 in 2012, $75 in 2013, $95 in 2014, and $122 in 2015. Just about any one-year holding period could have realized quick profits: you could have bought at $50 in 2012, and sold in the $70s in 2013. Or, you could have bought in the $90s in 2014, and then sold in the $110s in 2015. If you get a vibe that people collectively are selling the stock, either due to concerns about ESPN or valuation, and you have realized a short-term gain that you want to secure, you can understand why a sell decision happens.
But although every household has their own unique opportunity costs, I am not convinced that the great majority of households would be better off by releasing their ownership position in Disney. Heck, even Warren Buffett made the mistake of selling Disney stock. He bought 5% of the company for $4 million in 1966, and sold it about a year later for a 50% gain. If he held through the present day, he would be worth over $12 billion, anyway. That should be an insight that gives you pause: even if Warren Buffett had done nothing with his life labor-wise for the past half-century, the ongoing proceeds from a wise 1966 decision would have made him one of the richest 500 people in the world, anyway.
At Notre Dame in 1991, Warren Buffett said this in lecture:
“We bought 5% of The Walt Disney Company in 1966. It cost us $4 million. $80 million was the valuation of the whole thing. There was 300 and some acres in Anaheim. The Pirate’s Ride had just been put in. It cost $17 million.
Meanwhile, I looked–the whole company was selling for $80 million. Mary Poppins had just come out. Mary Poppins made about $30 million that year, and seven years later you’re going to show it to kids the same age.
It’s like having an oil well where all the oil seeps back in…in 1966, they had 220 pictures of one sort or another. They wrote them all down to zero on the books–there were no residual values placed on the value of any Disney picture up through the ‘60s.
So you got all of this for $80 million bucks, and remember Walt Disney himself was working for you. It was just incredible. You didn’t have to be a genius to look at it all and know that the Walt Disney Company was worth more than $80 million. It’s unbelievable… I mean, there’s no better system than to have something where, essentially, you get a new crop every seven years and you get to charge more each time…essentially, they [Wall Street] ignored it because it was so familiar.”
It is true that the extraordinary gains come from times like 1966, 1973-1974, and 2008-2009 when the company is both exceptional and trading at a discount. Building up cash and buying fast-growing companies during recessions is the best strategy, except for periods like 1982-1990 or 1992-1999 in which the market gains are so substantial that the opportunity cost becomes high because you are unable to convert your cash into productive assets and the amount of money you could have made owning productive assets eclipses the later favorable valuation you receive.
There is a little bit of cyclicity in the reported earnings at Disney–strong movie releases, recessions that drive down theme park attendance, and high initial acquisition costs explain why earnings do not move up neatly in a linear direction each year. However, if you step back and take an aerial view, you will be able to see how extraordinary the collection of intellectual property under the Disney umbrella truly is.
Since 1970, earnings per share have grown at 12.5%. Since 1980, earnings per share have grown at 14.8%. Since 1990, earnings per share have grown at 11.8%. Over the short-term? Earnings have quintupled at Disney since 2000, and grown by 16.5% these past ten years. The reason for the higher than usual earnings growth these past ten years is a shift towards a buyback strategy–the typical large-cap American stock spends nearly an equal amount on dividends and share buybacks. Disney, on the other hand, spends almost 4x as much on buybacks as dividends.
I am surprised that Disney is a company that regularly receives ridicule from an investment perspective. The empire is so vast that there will always be a component growing quickly, and relatedly, a component of the firm that is not delivering exceptional. This is a company that has grown earnings from $0.90 in 2000 to $5.05 in 2015, or even $2.54 in 2011 to $5.05 in 2015. The lucrative Star Wars release ought to propel Disney to double-digit earnings growth by the time we examine the stock at the end of next year. I do not share the opinion that Disney is a stock that should ever be sold, as it is one of the few enterprises in the entire world with inherent characteristics that offer high probabilities of perpetual double-digit returns. But I am not interested in you reaching a conclusion that agrees with mine, but rather, hoping that I can get you to think about the ways that headline risk, groupthink, and the desire to lock-in gains can affect your thinking. And if it does make your decision process suboptimal, hopefully the awareness is the first step in correcting it.