3 Reasons Disney Is A Buy And Hold Forever Dividend Dream Stock

Posted On September 12, 2018 1:00 pm

Dividend Profile: Safe, Fast Growing Dividends And Market Beating Return Potential

The most important part of any income investment, and what ultimately drives total returns, is the dividend profile. This consists of three parts: yield, payout safety, and long-term growth potential.

Company Yield Free Cash Flow Payout Ratio Expected 10 Year Annual Dividend Growth Potential Annual Total Return (From Fair Value) Valuation Adjusted Annualized Total Return Potential
Disney 1.5% 26% 10.2% 11.7% 12.8%
S&P 500 1.8% 38% 6.2% 8.0% 0% to 5%


Now it’s true that Disney’s current yield isn’t anything to get excited about. It doesn’t even match the S&P 500’s paltry payout. But what it lacks in size it more than makes up for in safety and strong growth potential.

Disney’s FCF payout ratio of 26% means that its fast growing cash flow nearly covers its dividend four times over. As a result once the Fox debt is paid off, it could potentially grow the dividend faster than earnings.

Of course there’s more to a safe dividend then just a low payout ratio. The balance sheet also needs to be strong.

  • Debt/EBITDA: 1.2 (industry average 1.9)
  • Interest Coverage Ratio: 22.4 (industry average 18.6)
  • S&P Credit Rating: A+
  • Average Interest Cost: 2.9% (return on invested capital 19%)

Fortunately Disney’s pre-Fox debt levels are very modest, with a leverage ratio that’s far below its industry peers. This is why its operating cash flow covers its interest payments more than 22 times over and it has a very strong credit rating. As a result it can borrow at rates far below its strong returns on invested capital. That means that any debt Disney does have helps to grow free cash flow and dividends in the future.

That dividend growth is likely to be at least as fast as earnings, which analysts expect to grow at 10.2% annually over the coming decade. That means that assuming it was at fair value, Disney would be expected to generate long-term total returns of 11.7% per year. However, from its current low share price, Disney is likely to actually deliver closer to 13% long-term total returns.

For context the S&P 500’s historical return has been 9.2% since 1871. And from current valuations Morningstar, BlackRock and Vanguard estimate the market will likely deliver between 0% and 5% annualized total returns over the next five to ten years. This means that Disney is potentially set to deliver more than three times the returns of the broader market. That’s thanks to this blue chip trading at such an attractive valuation.

Valuation: The Ultimate Buy And Hold Forever Blue Chip Is 10% Undervalued

There are many ways to value a company for but for stable dividend growth stocks like Disney the most time tested method is called dividend yield theory. Since 1966 this approach has helped to deliver market beating returns via a very simply approach.

Dividend yield theory says that stable business model dividend stocks have mean reverting yields. Or to put another way over time the yield will cycle around a relatively fixed level that approximates fair value. Buy when the yield is above the fair value yield and you’re likely buying a quality income producing asset at a discount. When the yield reverts back to the historical level you’ll get a valuation boost that juices your returns.

  • Yield: 1.5%
  • 5 year average yield: 1.5%
  • 13 year median yield: 1.2%
  • Estimated fair value yield: 1.35%
  • Estimated discount to fair value: 10%
  • Long-term annualized valuation return boost: 1.1%
  • Expected long-term annual return: 12.8%

Disney’s five year average yield has been 1.5% and its 13 year median yield 1.2%. Taking the average of these two figures I estimate Disney’s fair value yield to be about 1.35%. That means that today Disney is likely about 10% undervalued.

Over long periods (5+ years) a stock price is based purely on fundamentals and not short-term sentiment. This means that over the next 10 years investors can expect Disney to return to fair value which would mean the share price would likely rise 1.1% faster than earnings (and dividends). That means the total return potential of the stock from current levels is: 1.5% yield + 10.2% EPS/dividend growth + 1.1% valuation boost or 12.8%.

That’s a phenomenal return for a low risk, wide moat blue chip and makes Disney a great buy today. Of course that’s only if you’re comfortable with the risk profile.

About author

Dividend Sensei
Dividend Sensei

I'm an Army veteran and former energy dividend writer for The Motley Fool. I'm a proud co-founder of Wide Moat Research, Dividend Kings, and the Intelligent Dividend Investor. My work can be found on Seeking Alpha, Dividend Kings, iREIT, and the Intelligent Dividend Investor. My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives. With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams and achieving long-term financial goals.

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