The Walt Disney Company (NYSE:DIS) is a challenging business to evaluate due to the diversity of its revenue streams. Disney is a powerhouse in streaming and traditional media. As well it owns world-famous theme parks, Disney studios, and it manages a raft of brand merchandise. The ongoing impacts of COVID-19 also make it difficult to project earnings.
The variability in the stock price over the past year reflects the challenge in valuing DIS. One year ago, the shares were trading at $124. The stock rocketed up to more than $200 in early March of 2021, before declining to around $170 in mid May. From mid May to mid September, the shares have bounced around between $170 and $185 as investors struggle for direction.
The current share price of $176 is very close to the Dec.11, 2020 closing price of $175.72. The shares are at almost the same level as they were nine and a half months ago.
Source: Investing.com
Morningstar calculates a value of 35.2 for the consensus forward P/E for DIS, considerably lower than Netflix's (NASDAQ:NFLX) forward P/E of 45.9. Even though these two companies compete in streaming media, that's only a portion of Disney’s business. Other segments (such as the parks) are more constrained in their potential growth, thereby reducing the range of plausible P/E values for the company as a whole.
DIS has dramatically outperformed EPS expectations in the three quarterly reports since my last analysis (for FY Q1, Q2, and Q3). In FY Q2, reported on May 13, DIS EPS was 189% above the expected value. FY Q3 EPS, while less dramatic than Q2, was 46.5% above expectations.
Source: ETrade. Green (red) values represent amount by which EPS exceeded (missed) the consensus expected value.
I last wrote about DIS on Feb. 1, 2021, when I gave the stock a bearish rating. Over the almost 8 months since, DIS has gained 1.28%, as compared to 17.5% for the S&P 500.
At the start of February, the Wall Street analyst consensus rating was bullish, with a 12-month price target of $190.95, 12% above the share price at that time. I concluded that the bulls were making heroic projections for DIS and that the potential upside was more than offset by the uncertainties.
Source: Seeking Alpha
Along with the very high P/E in February, I was concerned by the bearish view implied by the options trading on DIS. The price of an option represents the market’s consensus estimate for the probability that the price of the underlying security or index (DIS, in this case) will rise above (call option) or fall below (put option) a specific level (the strike price) between now and when the option expires.
By analyzing calls and puts at a range of strike prices and a common expiration date, it is possible to calculate a probabilistic outlook for the underlying security that reconciles the options prices. This is the market-implied outlook. For those who are unfamiliar with the concept, I have written an overview post, including links to the relevant financial literature.
The February market-implied outlook for DIS showed substantially elevated probabilities for negative returns relative to positive returns, convincing me to give the stock a bearish rating at that time. The market-implied outlook also provides a projection for volatility (a more sophisticated version of the standard implied volatility) and the value in February was around 42%. This is high for an individual stock and particularly for a stock with expected 12-month return of 12% (the analyst consensus).
With almost 8 months since my last analysis, along with the very strong earnings recovery over this period, I am reevaluating DIS.
Wall Street Consensus Outlook for DIS
ETrade calculates the Wall Street consensus outlook from the views of 19 ranked analysts who have issued ratings and price targets for DIS within the past 90 days. The consensus rating is bullish (as it was in February) and the consensus 12-month price target is 23.8% above the current share price. The lowest 12-month price target is 5.1% above the current level. The consensus price target has risen considerably from its February level of $191.
Source: ETrade
Investing.com calculates the Wall Street consensus outlook using the rating and price targets from 27 analysts. The consensus rating is a buy and the 12-month price target is 19.55% above the current share price.
Source: Investing.com
The Wall Street consensus 12-month price targets calculated by eTrade and Investing.com are very close, implying a price return of around 22% (averaging the two). None of the analysts in either cohort gives DIS a rating below neutral.
Market-Implied Outlook for DIS
I have analysed the prices of call and put options at a range of strike prices, all expiring on Jan. 21, 2022, to calculate the market-implied outlook for DIS for the next 3.8 months (from now until that expiration date). I have also used options expiring on June 17, 2022 to calculate the market-implied outlook for the next 8.6 months.
The standard presentation of the market-implied outlook is in the form of a probability distribution of price returns, with probability on the vertical axis and return on the horizontal.
Source: Author’s calculations using options quotes from ETrade
The market-implied outlook to early 2022 is generally symmetric. There is not a well-defined peak in the probabilities, although the maximum probability (by a small margin) corresponds to a price return of +3%. The annualized volatility derived from this distribution is 27%.
To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).
Source: Author’s calculations using options quotes from ETrade. The negative return side of the distribution has been rotated about the vertical axis.
Viewed in this way, it is clear that there are consistently higher probabilities of positive returns than negative returns of the same magnitude over almost the entire range of possible outcomes (the solid blue curve is above the dashed red line for the most-probable returns). This is a bullish outlook from the options market.
Theoretically, the market-implied outlook is expected to have a negative tilt, with elevated probabilities of negative returns, as risk-averse investors bid up the prices of put options. In other words, for the market-implied outlook to be unbiased, options buyers and sellers would need to be risk neutral, with no inherent risk aversion. Theory suggests that investors, as a whole, must be risk averse. In practice, this means that the observed market-implied outlook should be considered to have a negative bias. This would make the interpretation of the market-implied outlook for DIS look even more bullish.
Looking out to mid 2022 by calculating the market-implied outlook using options that expire on June 17, 2022, the view is largely neutral. Rather than seeing elevated probabilities of positive returns, the probabilities of negative returns are higher for returns in the range +/-15% (from 0% to 15% on the chart below). For larger-magnitude returns, the probabilities are very similar. Considering the tendency for a negative bias in the market-implied outlook, I interpret this result to support a neutral rating. The annualized volatility derived from this outlook is 28%.
Source: Author’s calculations using options quotes from ETrade. The negative return side of the distribution has been rotated about the vertical axis.
The market-implied outlook for DIS is bullish to early 2022, shifting to neutral by the middle of the year. The annualized volatility is 27%-28%, far lower than the 42% in February. The market-implied outlook for DIS has dramatically improved since February, when it was decidedly bearish.
Summary
The consensus opinion of Wall Street analysts was bullish on DIS in February and continues to be bullish. The share price has languished from February until now.
The consensus price target has risen considerably over the past 8 months as DIS has turned in several quarters of very solid results. The consensus 12-month price target is 22% above the current share price.
The expected volatility for DIS has fallen substantially since February, as well. As a rule of thumb for a buy rating, I want to see expected 12-month return that is at least ½ the projected volatility. DIS, with expected return of 22% (taking the analyst consensus at face value) and expected volatility of 28%, far exceeds that cutoff.
The market-implied outlook is bullish into early 2022, shifting to neutral to mid 2022. Considering Disney’s impressive EPS growth in recent quarters, the substantially improved Wall Street consensus outlook, and the bullish market-implied outlook, I am changing my rating on DIS to bullish.