April 26, 2015

More Disney Shares Added to the Souvenir Portfolio After a Weekend at Disneyland

As I briefly mentioned in passing while I was in Anaheim, I continued my tradition and bought more shares of The Walt Disney Company as a souvenir during the weekend trip to Southern California (hoodies and ball-caps are nice momentos, but why not buy the business itself?).  This year, there were two trades.  The first trade was placed on Saturday during lunch at Club 33, and executed Monday morning.  I then made an additional purchase in memory of The World of Color at Grand California Adventure on Sunday, June 16th, but the trade didn’t execute until Thursday, June 20th because I wanted to get through the financials on the plane flight home.  I’ve updated the real-time Google spreadsheet I keep on this experiment.

Since I began this program less than two years ago during our Walt Disney World vacation in August of 2011, I’ve picked up 305 shares, with each trade tied to a specific memory, all of which I have posted here with photographs of when and where I decided to buy the stock.  The shares have a current market value that bounces between $19,000 and $21,000 give or take a few percentage points depending upon the mood of the stock market on any given day.

This entire experience has been the most enjoyable thing to me because I plan on someday using the shares for something unique, like buying a vacation house for my family or gifting them to my children and grandchildren in trust funds, as they provide a mechanism for me to explain how capital works; how businesses operate; how financial statements can be read; why return on equity matters; how to adjust for returns on tangible capital to assess the true economics of the underlying enterprise independent of accounting purchase adjustments; why dividend records are important.  The whole program started out small – you saw it yourself when I bought the very first block of shares – but, God willing given a few decades, this will turn into something quite large that expands far beyond the Walt Disney Company.  I’ll probably end up with dozens of companies, all destined to somehow benefits subsequent generations and not myself.  Kept up with diligence and wise stewardship, it is almost mathematically impossible that this souvenir program, which was started on a whim, doesn’t end up with a seven-figure or larger pile of wealth that is entirely extra by the time I reach retirement age.  I’m only 30 years old now.  

It also gives me something else besides the KRIP I can discuss on the site since most of my activities are kept private.  It lets me show rather than tell; a teaching method that works better with most people.  

How to Think About Business Ownership

Thus far, I’ve only bought shares of the Walt Disney Company for the souvenir portfolio, but that will change in the future.  For now, we’ll keep it focused on this one firm for the sake of simplicity.

What I am really buying when I pick up these souvenir shares is an ownership stake in the Walt Disney media and theme park empire.  There is no “Disney stock” in the sense most people think of stocks.  There is only ownership of a corporation, and that corporation, in turn, owns things that consume and produce cash.  As of the end of last fiscal year, the Walt Disney Company generated $42,278,000,000 in sales and enjoyed pre-tax profits of $9,964,000,000.  After paying income taxes and deducting profits attributable to non-controlling interests, the company was left with $5,682,000,000 in net income.  

That same year, the diluted average shares outstanding – the number of pieces into which the Walt Disney Company was divided if you think of the entire business like a giant apple pie that has been cut into slices – was 1,818,000,000.  In other words, each share, or “slice” of the business, entitles you to 1/1,818,000,000ths of the company, including any profit or losses it generates.  Since almost all corporations are “non-assessable”, if there are losses, the creditors can’t come after you, as the owner, but, rather, are limited to the assets held in the company, so your maximum theoretical loss is limited to what you’ve put into the business.  That wasn’t always the case.  There was a time when even major companies, such as American Express, had shares that were assessable so the firm could survive.  The business would have the right to demand you kick in more cash to help cover its losses and survive, resulting in lower valuation multiples to account for the risk.  That is another essay for another day.

Last year, this means after-tax profit per share was $3.13 because Disney took the $5,682,000,000 in net profit and divided it by the 1,818,000,000 pieces.  If you owned all 1,818,000,000 shares, you’d get to keep all $5,682,000,000 in after-tax profit.  That’s the fresh, new surplus money generated in the past twelve months from selling Mickey Mouse chocolate covered apples, Donald Duck coffee mugs, digital downloads of Cinderella and 101 Dalmatians, theme park tickets, hotel stays, cups of coffee, ESPN licenses, cruises, advertisements on The Disney Channel and other cable networks, tickets to Broadway plays, and much, much more.  

(Fun fact: The Walt Disney Company sees more than $115.83 million per day in sales flood into its bank account.  After all expenses, salaries, taxes, and other costs have been paid, the stockholders are left with a net profit of $15.5 million every 24 hours that they split amongst themselves.  The original Disneyland cost $17 million in 1955 to build, or $143.77 million today in inflation-adjusted terms.  Were Walt Disney doing it over, again, he could write a check and pay cash for the park in 9 days and a few hours.  The level of growth from those early years is amazing.)

Walt Disney Company Joshua Kennon Main Street Disneyland

Walt Disney Profits


Walt Disney Company Common Stock Certificate

The Board of Directors, elected by the stockholders to represent their best interest, decided to mail $0.75 of that $3.13  in the form of a cash dividend – you literally got a check in the mail or saw a direct deposit in your account – and hang on to $2.38 to expand the business, improve the facilities, maintain rides, invest in new projects, buy back stock, or whatever else they think will earn a good rate of return.  The reason Bob Iger is such an amazing CEO is he has used the money retained by the Board of Directors to make Disney a much stronger company, acquiring Pixar, Marvel, and Lucasfilm, at prices that caused profits to skyrocket, making each piece of the company more valuable as other investors decide they want to offer you more cash for your ownership stake.  That is what I mean when I say the stock market doesn’t exist – that price you see on computer screen is just the last price at which two other humans, a buyer and seller, agreed to exchange pieces of the Walt Disney Company.  Unless you are interested in buying more, or selling what you have, it is not very meaningful to you.

My souvenir shares now represent 305/1,818,000,000th ownership in the company.  To get a rough idea of what I own, we’ll look at last year’s figures (they are now slightly out of date because Disney has announced its quarterly profits and earnings are going to be higher this year, but it will get us in the ballpark).  If we take 305 shares and multiply it by the $3.13 each share generated in after-tax profit, we see that my ownership stake made $954.65.  That is, of that $5,682,000,000 in after tax profit, $954.65 belongs to me.  It’s mine.  I am the legal owner of it.  We know that $0.75 was distributed as a cash dividend, so we take 305 shares x 75¢ and discover it is $228.75.  

Joshua Kennon Aaron Green World of Color Disneyland

In other words, I own 305/1,818,000,000th of the Disney company, which represents $954.65 in after-tax profits, of which $228.75 was paid out in cash and $725.90 was retained by management to build the business.  That is what I own.  The stock price I see cross the ticker is really just telling me what other people are willing to pay me for those profits at this particular moment.  It’s a real-time auction, sort of like Christies or Ebay, only people are bidding on pieces of companies, slices of the corporate pie, instead of furniture or used clothing.  When I see that the current market value is $20,000 or so, that is all it means.  There are men and women out there, sitting in their home and offices, that are willing to write me a check for $20,000 if I give up my ownership stake in Disney, including my right to those profits and dividends.  If I want to take them up on the offer, I tell my broker to sell the stake and he takes a small fee for facilitating the trade.  The buyer gives me cash, I give him my ownership pieces.

It doesn’t matter how rich or poor you are, that is how it works in a fair capitalistic society.  Steve Jobs sold his company, Pixar, to Disney and received 138,000,000 shares of stock in exchange since he demanded pieces of ownership instead of cash.  When he died, he left these shares to his wife, Laurene, in a trust fund.  That means last year, Laurene’s cut of the net profits of Disney came to $431,940,000, of which $103,500,000 was mailed to her as a cash dividend and $328,440,000 was retained by Disney to strengthen the business for the future.  She owns 138,000,000/1,818,000,000ths of the business.  She is a very smart, highly educated woman.  Do you think she sits around and worries about the market value of those shares?  That if she wanted to sell those shares to other investors, she might be able to get just shy of $9,000,000,000 for them?  No!  What would she do with $9 billion in cash?  It would lose value with inflation.  She wants her cut of Disney’s net profit and dividends so that the money is being productive, churning out more money.  It is about the underlying company.

The same goes for George Lucas.  When he sold his stake in Lucasfilm to Disney, he took a combination of cash and stock.  He was paid a total of $4.06 billion, half of which was in the form of liquid cash, the other half of which came in the form of 37,100,000 shares of The Walt Disney Company.  He owns 37,100,000/1,818,000,000th of the firm.

People Make Investing Too Difficult … Focus on the Net Earnings and Risk

People make stocks too hard.  Your job is to buy profits and minimize risk.  That’s it.  You want to acquire assets so that your share of the net income and the dividends that are distributed go up over time at a rate far faster than inflation.  When you understand the mechanics of what is happening, you realize that seeing a stock fluctuate by 50% in a year isn’t really a big deal.  Your job is to look at the profits now, where you think the profits will be in five years using good business judgment, a healthy knowledge of accounting so you can read the financial statements, and an understanding of the economic forces that are likely to help or hurt the enterprise, and then decide on the maximum price you can pay so that you are hitting your required compounding rate.  The more you pay relative to future earnings, the less you make.  The less you pay relative to future earnings, the more you make.  While short-term the market can diverge from this truism, in the long-term, it is the only thing that matters.

Most of the time, people are too optimistic.  They pay too much for $1 in profit and end up experiencing painful losses.  The opposite is possible – sometimes, you can be too conservative.  One example: Two years ago, I thought Disney was fairly valued at $33 per share but then Bob Iger’s decisions started paying off big time and the economy improved, causing net profits per share to skyrocket from $2.03 in 2010 to $3.13 last year.  That is an increase of $1.10 per share, or 54%.  That was not on the horizon at the time!  That is why a great management team can make all the difference in the world.  The move in the stock price from $33 to $65 reflected this as investors realized each piece of the company was worth far more than previously thought, especially since the earnings were somewhat stable – they weren’t one-time profits, but rather represented ownership in new franchises, like the Avengers or Iron Man, that will continue to pound out fresh money for decades.

(Note that the earnings per share increased much more quickly than the overall earnings of the business.  If you want to manage your own finances, you should be able to explain the reason by looking through the financial statements.  It’s a fairly simple accounting test that sorts out the beginners.)

What would happen if investors decided they were only willing to pay $25 per share for Disney tomorrow, even though profits didn’t move?  Should you be upset that your portfolio fell by 60%+?  It depends.  Did the earnings per share collapse?  If the business is still earning $3.13 per share, and expected to grow in the future, you should be thrilled!  You can now buy far more ownership at a much better return than you could before the drop.  Who cares that you have less on paper?  Your focus should be on your cut of the earnings and dividends.  If the earnings fell to $0.50 per share, and were expected to stay there for years, you should be very concerned because even $25 per share would be too high a price.  Likewise, should you be excited if the stock skyrocketed to $200 per share?  It depends.  If the earnings are still $3.13, that cannot be even remotely justified, so a wise person would consider liquidating his ownership stake.  If, on the other hand, profits per share jump to $10 and will continue to grow at a good rate, it’s perfectly reasonable.  Why would you want to part with an excellent firm with strong competitive advantages simply because it is more successful now?

You cannot predict the stock market because you cannot predict how rational or irrational buyers and sellers as a whole will be.  Instead, to repeat myself one more time, you must focus on growing your share of the net earnings and dividends.  You want a collection of assets that, 3-5 years in the future, will be generating the greatest amount possible in both of those figures, while avoiding risks such as over-leveraged companies or derivatives.  The rest takes care of itself, as long as you are purely rational and don’t get upset by seeing your stocks drop by half.  It will happen.  The value of your ownership stake is not determined by the stock price alone, it is anchored to the cash the assets will pump out for you.  If the stock market closed for ten years so that there could be no buy or sell orders placed, I’d still have an ownership stake in Disney that would result in more money being mailed to me each year.  That is the source of value.  That is the real thing that matters.  The stock market is just an illusion; a concept we use to describe the buy and sell decisions of a lot of business owners and would-be-business owners.

I would be ecstatic if The Walt Disney Company shares were to fall to $45 or less.  As it stands now, the firm looks fairly valued.  A drop of 30% or more, if earnings were still intact, would get my attention for the main deep value portfolios.

  • Dave

    Very informative article, Joshua. This is something I would point people to who have questions about how stock valuation and markets work.

    I would really like to see an article about the numbers on the bottom half of your Google spreadsheet. Particularly, the 4 numbers from the “rough, back of the envelope calculation” on down. I’m curious about what you use to determine these 4 numbers, and how they relate to the bigger picture of your valuation of the stock.

    • joe pierson

      He talked about this in previous Disney posts (using the dividend adjusted PEG ratios of 1, 1.5, 2)

  • Ben

    Great post, thank you!

  • Scott McCarthy

    There was a time when even major companies, such as American Express,
    had shares that were assessable so the firm could survive. The business
    would have the right to demand you kick in more cash to help cover its
    losses and survive, resulting in lower valuation multiples to account
    for the risk. That is another essay for another day.

    I’d love to read that essay. Seems like an interesting concept to organize a shell company with assessable shares and market it as a reverse takeover target. Might have some value as a poison pill – structure a transaction that won’t close for 10-20 years, but would be accelerated to 15 days upon receipt of a tender offer by the real company. Charge a $50-100k break-up fee or something, payable up front. I mean, that’s probably not legal, but still.