One of America's beloved companies has produced an annualized return of 12.8% over the past three decades, easily beating the 7.5% annual return on the S&P 500.
From its 2011 lows to its all-time high in August 2015, the stock surged more than 350% as investors clamored to grab their stake in one of the world's most recognized brands. And during this time, its trailing price-to-earnings (P/E) ratio more than doubled.
As a die-hard value investor, I found it difficult to justify buying shares given how expensive they were. But now, with the stock trading at a nearly 20% discount to its all-time high, I'm ready to pull the trigger.
The House of Mouse Is Finally Affordable
Shares of The Walt Disney Company (NYSE: DIS) have been under pressure since August, when CEO Bob Iger acknowledged subscriber losses in the media segment. This segment accounts for 45% of sales, and the warning sent shares tumbling.
After a quick rebound, shares plunged again when a November regulatory filing confirmed the negative trend. For instance, Disney's most profitable channel, ESPN, saw 7 million subscribers disappear in just two years -- a 7% falloff in a relatively short time.
The losses were almost entirely a result of viewers dropping their cable plans to watch content online. While this may not be a trend Disney can reverse, nor is the $162 billion entertainment empire powerless against the cord-cutting trend.
Networks like HBO and CBS (NYSE: CBS) have already started offering direct-to-consumer web-based services to stem losses on pay-TV content. Disney is also dabbling with this, and while a larger rollout might cannibalize some of its cable revenue, it could create another significant revenue stream for the company. For example, ESPN already benefits from the highest affiliate fees per subscriber of any cable channel, so monetizing its popularity online could be a big win.
Disney is also creating some core assets that should drive higher sales over the next year.
Its studio entertainment segment is becoming a powerhouse revenue generator, accounting for 15.9% of sales in the most recent quarter (fiscal Q2) compared to 13.5% a year ago. Studio revenue jumped 22% year over year in the quarter, and it looks like the rest of 2016 could be just as strong.
Thirteen movies are slated for release this year, including some potential blockbusters like the "Finding Nemo" sequel in June and a long-overdue reboot of the 70s classic "Pete's Dragon." Disney still has one more film to release this year from the Marvel franchise, November's "Doctor Strange," and a "Star Wars" spin-off, "Rogue One," is scheduled for December.
Disney has developed an integrated storyline within a shared universe for its Marvel movies, driving viewers to see all the films to get the complete picture, and the studio seems to be planning the same thing for the "Star Wars" franchise.
Meanwhile, Disney's parks and resort segment, which represents 30% of sales, is about to get a boost from the June opening of Shanghai Disney. Increased opening expenses for the new park weighed on second-quarter earnings, but those costs should be lifted and revenue should start flowing in.
Disney has become a cash flow machine, generating $7 billion in free cash flow over the past year, even with $4.9 billion in capital expenditures. The company has returned almost $11 billion to shareholders during the past year through dividends and share repurchases, or about 6.7% of its market cap. With more than $5 billion in cash on the balance sheet and a debt-to-equity ratio of just 35%, investors can expect that trend to continue for the foreseeable future.
However, even though Disney boosted its semiannual (July and December) dividend 19% last year, its 1.4% yield is nothing to write home about -- especially considering this is a blue chip-stock with strong cash flow.
But income investors need not despair, because we can boost Disney's yield to almost 15% with a simple covered call strategy.
How To Unlock A 15% Yield On Disney
Analysts are expecting earnings to increase 13% to $5.81 per share in fiscal 2016, ending in September, and 7% to $6.23 per share next year. With growth in the studio segment and temporary costs in the theme park segment giving way to sales, I think Disney could exceed analysts' estimates over the next few quarters. I also believe shares could easily trade back to the highs made earlier this month above $106.
With DIS trading at $99 at the time of this writing, we can buy 100 shares and simultaneously sell one DIS Jul 100 Call, which is trading around $2.15 per share ($215 per contract). That gives us a net cost of $96.85 per share, which is a 2.2% discount to the current price.
If DIS closes above the $100 strike price at expiration on July 15, our shares will be sold for that price. In this case, we will make $1 in capital gains, plus the $2.15 premium for selling the calls and the July dividend, which is expected to be around $0.71 per share. That gives us a total return of $3.86 for a 4% gain over our cost basis of $96.85. Since we'd earn that in just 58 days, it works out to an annualized return of 25%.
If shares don't get called away, we can continue to sell covered calls on the position. If we could earn $2.15 in additional income every two months, that would bring our total annual income to $14.32, including dividends. That brings the yield on this blue-chip stock to 14.5% -- and shares never need to move an inch.
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This article originally appeared on ProfitableTrading.com: This Blue-Chip Favorite is Finally Cheap Enough to Buy