As we mentioned in our May 2020 update on Disney (NYSE:DIS), the stock’s problems seemed to be more related to systemic weakness in the market rather than a problem with our original argument for the trade. We feel that our analysis has proven to be correct so far. And importantly, we are still optimistic that DIS will outperform despite recent volatility in the market.
When we chose DIS for our trade of the year, we felt the stock had two advantages. First, a new focus on streaming media and media franchises, like Frozen. The second is its solid balance sheet. This should attract investors if the market channels again like it did in June, or even for a longer period like it did during the “earnings recession” of 2015.
DIS stock is dividing sentiment, and for just cause. On the one hand, any increase in Covid-19 infection rates will harm travel and recreation stocks. However, on the other hand, home quarantines and social distancing increase demand for Disney’s subscription and cable media business lines. These should more than compensate for the damage from reduced travel.
Too often investors think of Disney’s media properties as ESPN and the movie business. However, as DIS has moved to take on Netflix (NASDAQ:NFLX) with its investment in Hulu and the launch of Disney+, we think it is positioned to grow overall margins significantly. DIS signed up over 60 million subscribers to its Disney+ service in the first 10 months it has been available.
DIS Stock Benefits From Pivot to Online Releases
As the company pursues a more focused strategy toward online releases, such as the recent launch of the live-action Mulan and another season of The Mandalorian, we think the company has the power to raise subscription prices. It should also be able to capture market share from competing services that are beginning to look more stale. Currently, 19% of Disney’s revenue comes from streaming, and the company expects to earn $11.2 billion in direct-to-consumer revenue this year. This is better than any of its other old-media peers.
As you can tell, our case in favor of DIS stock for the Best Stocks contest is focused on the company maintaining flat performance in its travel and resorts businesses as the Covid-19 pandemic persists. At the same time, we think Disney can grow its streaming business.
However, as much as we wish it weren’t the case, some serious risks are facing DIS this year.
Risks, Risks, Risks
The company has gone through a few rounds of bad press over the last few weeks. Relationships with the Chinese government (including credits in the movie Mulan) have alienated many consumers. The company is also justifiably facing blowback from how it has treated minority actors like John Boyega.
Like most retail companies, we are concerned about Disney’s ability to maintain its profit growth if the unemployment picture does not continue to improve. The likelihood of another round of stimulus from Congress and the White House is also a worry. Many consumers may pull back on spending if the government does not reinstate special unemployment benefits.
In fact, the situation for DIS is serious enough that we might have considered suggesting that investors take their money off the table or reallocate it to some other position if it weren’t for the technicals. These indicators are painting a much more optimistic picture.
Technicals Paint an Optimistic Picture of Disney Stock
From a price perspective, DIS is at a very interesting inflection point. The bad press and a soft market have pushed the stock to the top of the price-gap that opened after earnings on Aug. 5. Remember, the company reported better-than-expected earnings.
Traditionally, bullish gaps like this should be a strong layer of support. This is especially true if the factors driving the price lower are short-term issues like bad press. Opportunities like this are always interesting to us. For example, we recently used a similar buying opportunity to take some quick profits on Nike (NYSE:NKE) during all the volatility of September.
In the studies we have done on this type of technical setup, support should be considered to still be “in play” as long as the entire gap isn’t “filled.” In this case, we feel support is still likely to hold as long as the price does not close below $117 per share.
The drawback to a technical setup like this is the projection from this level is usually fairly shallow. In this case, we would feel confident that a bounce off support has a very solid chance to take the stock to $145-$150 in 2020. However, forecasts beyond that level depend on the company continuing to grow streaming revenue and stabilize its travel and resorts businesses.
Best Stocks: Disney Presents an Attractive Risk/Reward
We originally selected DIS as our pick of the year because of the growth opportunities we saw in streaming and consumer spending. However, the disruption that has accompanied the pandemic has narrowed its path to higher prices in the short term. We feel that the stock has created an attractive risk/reward that we want to take advantage of. At the same time, we recommend investors monitor the fundamentals for any negative changes.
Investors should scale back positions if growth looks less likely in the fourth quarter.
On the date of publication, John Jagerson and Wade Hansen did not hold (either directly or indirectly) any positions in the securities mentioned in this article.
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