The Perfect Gift for Your Children or a Lump of Coal?

James is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

We all know how important investing is to our future.  But how can we impress that fact upon our children?  The trick is to make them owners of things they love.  Let them get that warm and fuzzy feeling every time they receive a dividend or walk into a store in which they have a share of ownership.

It just so happens that two iconic American institutions that children have loved for generations just went on sale.  Could this be a gift from Santa or a cruel joke by The Grinch?  Let's take a closer look and see if we should add these to our children's long term portfolios.

Disney (NYSE:DIS) is a name that every child knows.  What they might not know is that Disney is an empire that covers television, children's books, video games, movies, consumer products, as well as the theme park world.  In October of this year Disney announced the purchase of Lucasfilms, which has rights to Star Wars and Indiana Jones among other assets.  This is the latest in a round of content purchases that included Marvel (2009) and Pixar (2006).

Disney is currently trading at $49.40 which is about 8% below its 52 week high of $53.40.  Not a large discount over the recent high, but still the largest drop off in stock price we've seen this year.  Looking at the one year chart (Figure 1) we can see this has been a steady gainer all year long and it looks as if the recent pullback is now over having found support just above the 200 day moving average.

Figure 1:

 

 

At first glance all the valuations look impressive except one, the yield.  While a 1.5% dividend yield may seem unimpressive the stock has seen sizable price moves upward which have negated the 5 year average dividend growth rate of 11.16%.  With conservative management, reflected in the low payout ratio of 19% vs. an industry average of 34%, you can expect the dividend increases to continue at a reasonable pace as they have in the past.

Even with the recent rise in stock price the valuations still remain very attractive.  A P/E of 15.90 with a Forward P/E of 12.80 and a 5 year PEG of 1.23 all point to a reasonable current price and good things in the future.  Comparing Disney with the industry average (Figure 2) we can see that Disney is slightly undervalued and clearly outperforming.

Figure 2:

 

Valuation Disney Industry
P/E 15.90 16.30
Yield 1.5% 1.0%
Dividend 5 Year Growth Rate 11.16% 9.62%
Net Profit Margin 5 Year Average 11.40% 6.70%
Return on Assets 5 Year Average 6.50% 3.10%
Return on Investments 5 Year Average 9.40% 4.40%

Given the current price around $49, this seems to be a reasonable entry point.  Taking into account projections and fair valuations I have a 12 month price target of $64.  The brand, its products, and the experience it can provide are unique and have the staying power that lasts from one generation to the next.  With the recent acquisitions it's very obvious that management is looking well into the future, in terms of both development as well as generating sustainable cash flow, by purchasing the rights to profitable assets.  This looks like a true holiday gift from Santa.

 

McDonald's Corp. (NYSE: MCD) is a name on children's lips in the 119 countries around the world where it has operations.  Remember back when you were little and Happy Meals brought that giant smile to your face? Well your children still feel that way about McDonald's today and great marketing is making sure that will never change.  Yes, I'm going to give the marketing prize to McDonald's.  They have a fun vibe, playsets, a not so scary clown, bite sized kid friendly food, and promotions that align perfectly with all the hit movies for kids.

McDonald's is currently trading at $86.55 which is about 15% below its 52 week high of $102.22 (Figure 3).  It has seen a recent pullback from its highs due to concerns over valuation (the first decline).  That was followed by a miss in same store sales and speculation that competitors were gaining market share.  Analysts piled on after the fact with downgrades and the stock was hit further (the second decline).  Has McDonald's seen the worst of its price decline?  

Figure 3:

 

 

Let's take a quick look at valuations just in case we might be missing something.  The P/E of 16.30 at first glance looks attractive along with the 3.6% yield.  However, with a payout ratio of 53%, compared to an industry average of 39%, I don't think we will be seeing many increases in that dividend in the near future. But we need to dig deeper (see Figure 4) and get to the statistics that tell the whole story about where McDonald's is headed short term based on the most recent quarter (MRQ).

Figure 4:

Valuations McDonald's Industry
Sales (MRQ) vs Qtr 1 Yr Ago -0.20% 15.50%
EPS (MRQ) vs Qtr 1 Yr Ago -3.50% 13.30%

New management took over in mid 2012 and the stock has been in limbo since then.  Over the last 90 days alone, on average, analysts have lowered their earnings predictions for 2013 by just over 5%.  Without clear direction on how to deal with declining same store sales along with a plan to retake market share I'm afraid that McDonald's might continue to decline and therefore cannot be put on my long term buy list.  Perhaps next year Santa might giftwrap this one for us but right now McDonald's is looking like a lump of coal.


Lulupoopsalot has no positions in the stocks mentioned above. The Motley Fool owns shares of Walt Disney and McDonald's. Motley Fool newsletter services recommend Walt Disney and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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