Disney Through The Eyes of Warren Buffett

I presume that, when Warren Buffett discusses the rationale for a particular investment, he holds back a little bit of the rationale for making the investment so that his theses aren’t immediately adopted by others and thus driving the price of the stock up. I say this without negative judgment, as competitive insights are hard-won and Buffett owes no duty to third parties to diminish the effectiveness of his own insights.

Specifically, I was thinking about Warren Buffett’s investment in American Express, an important part of his lifetime accumulation of wealth. As you may know, he made a lot of money in 1963-1964 by purchasing American Express stock through his seven Buffett Limited Partnership, and the quick tripling of the stock price gave Buffett an Omaha fortune and regional credibility as an investor.

Buffett continued to buy this stock en masse during the late 1980s and early 1990s on behalf of Berkshire Hathaway, and he owns these shares to this day.

An important question to ask is: Why?

I believe it is three reasons.

The first two are intertwined and relate to the fact that American Express participates in what economists call a “two-sided” market. It’s just a fancy way of saying that the same transaction makes money from two participants. If you go to Wal-Mart and pay with an American Express card, American Express shareholders earn a transaction fee that Wal-Mart has to pay, and in the event that the cardholder does not make a timely payment, the cardholder will have to pay interest to American Express.

It is quite the unique wealth engine. Each transaction generates a small fee, and in the comparatively rarer event of non-timely payment, the same transactions results in the payment of high interest which is a very payment from the cardholder to the American Express.

The third reason relates to the first two. There is a high barrier to entry for starting a card company. Retailers and other providers do not want to pay fees on sales unless they absolutely must. They wish Visa, Mastercard, and American Express didn’t exist, but instead, are tolerated out of necessity. There is strong cultural inertia against the creation of a new card company and therefore the status quo oligopoly is likely to persist.

That is why, in spite of mediocre management and the comparative competitive excellence of Visa and Mastercard, American Express continues to compound at 11% over super long periods of time. The business model has passed Buffett’s “ham sandwich” test.

I believe this insight will explain why Disney will compound at a similar rate over the long haul. In a world where everything is overpriced in a way that stock market analyzers have to stretch to justify it as an investment, Disney trades at $110 and is expected to earn $7.40 per share next year. Okay, that’s 14.8x earnings. In my book, that marks it as an excellent business trading at a slight discount.

Just as Kraft-Heinz has become a branded food consolidator with its acquisition of branded products that run the gamut from ketchup to macaroni and cheese, Disney has become a big media consolidator in that it owns media networks, including ABC and ESPN, theme parks that include Magic Kingdom, Epcot, Hollywood Studios, and Animal Kingdom, and owns a vast movie rights and operates cruise lines.

Although it does not participate from the same transaction in quite the same way that American Express does, it does exhibit the characteristics of some type of multi-sided market in that the success of, say, Star Wars in its Lucas Production Studios division through the purchase of movie tickets will lead to the sale of Star Wars merchandise online and in retail stores and can support theme park attractions as well. And it can along the same stories, be it Mickey Mouse or Mary Poppins or Beauty & the Beast or Snow White, from generation to generation so it can profit over and over again from the same archetypal stories that have sustained importance to its customer base.

And furthermore, Disney also has the high barrier to entry advantage because it has successfully lobbied for the protection and extension of its intellectual property. If Disney never lobbied the U.S. Congress, you could sell Mickey Mouse merchandise on the streets right now because prior intellectual property right protections would have led to Disney’s loss of exclusivity by now. Disney’s secret sauce is that intellectual property is incredibly valuable, and it is able to repetitively profit from the same intellectual property over and over again while excluding competitors from intruding upon it.

Disney’s profits go up every year. Literally. There has been no year-over-year period over the past thirty years in which the subsequent year’s profits failed to exceed the previous years. This makes sense. It owns vast intellectual property rights that have the prices raised every year, has an ever-expanding audience, and pays out a low dividend so most earnings are retained. No wonder it rolls on and on.

Over the past decade, Disney’s profits have grown by 13.0% annualized. That is incredibly for a $165 billion company that has very strong safety characteristics.

When I make an investment in a stock that I intend to hold for life, I want to get three stars aligned: (1) a high probability of double-digit growth; (2) safety of the earnings power such that bankruptcy would be as close to unthinkable as one can find in the world; and (3) an attractive valuation so that the future growth of the business will fully be realized in stockholder returns. Disney fits that profile now, and I expect it will beat the S&P 500 substantially over the coming quarter-century.

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