Is It Time to Take Profits in Walt Disney Co. Stock?

By Markets Fool.com

Shares of Disney have risen 33% over the past year, easily outpacing the S&P 500's 12% gain. But after that big rally, investors might be thinking about taking some profits off the table. Let's discuss the reasons for selling and holding Disney stock at current levels, and which make more sense.

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Source: Pixabay

Why some people are selling
The first issue with Disney is its valuation. Its trailing P/E of 23.5 is higher than its own five-year average of 21.4 and the S&P 500's current P/E of 21. Disney's direct competitors, Time Warner and Fox , respectively, trade at 21 and 9 times earnings.

With Fed chief Janet Yellen recently claiming that market valuations are "generally quite high,"Disney could be pulled back by fundamental gravity. However, investors should remember that higher growth stocks generally trade at higher multiples.

The second problem with Disney is its cable networks business, which generated nearly a third of its revenue and over half of its operating income last quarter. During the second quarter, cable networks revenue rose 11% annually, but operating income slipped 9%. That decline was attributed to higher programming and production costs at ESPN, which were needed to secure college football and NFL programming rights.

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Source: Pixabay

In addition to rising programming costs, ESPN could lose viewers due to the cord-cutting movement. Disney recently sued Verizon -- which offered ESPN in a cheaper "skinny" bundle of channels -- claiming that it breached their original contract by letting consumers pick packages that didn't include ESPN. The pressure between higher programming costs and cable bills could continue weighing down Disney's cable division.

Why some people are holding
Despite those weaknesses, investors shouldn't overlook Disney's core strengths.

Disney's Parks and Resorts revenue rose 6% annually last quarter and accounted for 30% of its top line. Operating income -- which accounted for 16% of Disney's bottom line -- soared 24%, fueled by higher costs and higher guest spending. In other words, Disney can keep raising prices across the board without affecting visitor volume. In 2016, Disney will open its Shanghai Disney Resort, which could serve as a launchpad into other major Chinese cities.

Revenue and income fell year over year in its Studio Entertainment Division, but that decline was expected due to Frozen's record numbers in the prior year quarter. But looking ahead into the end of the year, some big upcoming films could bolster the segment -- which accounted for 13.5% of Disney's revenue and 12% of its operating income last quarter.

Avengers: Age of Ultron, which recently hit theaters, is expected to easily top $1 billion at the box office. The next Marvel film, Ant-Man, will arrive in July, and Star Wars: Episode VII will hit theaters in December. Pixar will also release two films -- Inside Out and The Good Dinosaur -- later this year. Those films will all likely generate big box office returns for Disney.

Avengers: Age of Ultron. Source: Marvel

Healthy demand for Frozen and Marvelmerchandise also helped Disney's consumer products division notch double-digit sales and profit growth last quarter. Profit at its Interactive division, boosted by strong sales of its Infinity virtual toybox of collectible figurines, also rose by the double digits.

What you shouldn't overlook
Disney investors also shouldn't overlook the company's ability to quickly maximize a franchise's growth across multiple business units.

The Marvel Cinematic Universe, for example, straddles the film and TV universes with tie-in shows like Agents of SHIELD and Agent Carter. Licensed toys and games strengthen the consumer products and interactive divisions. Marvel also provided fans with a clear timeline of the universe through 2019.

Disney also capitalized on the success of Frozen by adding themed attractions to its theme parks, airing a mini-sequel and tie-ins with Once Upon a Time on ABC, authorizing tie-in novels, and flooding stores with Frozen merchandise. Disney will likely do the same with Star Wars, letting the franchise cast a halo effect across multiple business divisions.

Other media companies don't operate at that level of efficiency. Sony , for example, rebooted Spider-Man but is having trouble building a universe around the franchise. Time Warner's Game of Thrones seems like an ideal candidate for spin-off movies and shows, but the company hasn't moved forward with the idea. Warner's DC Cinematic Universe, centered around Superman and Batman, also seems tiny compared to Marvel's expansive film universe.

Why I'm not selling yet
As a long-term Disney shareholder, I don't plan to sell my shares anytime soon. Its valuation is a bit high and ESPN's weight on the top and bottom lines is worrisome, but I believe that the continued growth of its other business segments should offset that weakness. Therefore, it would be silly to sell Disney with Star Wars, Shanghai Disney Resort, and more Marvel films all poised to generate billions more in revenue.

The article Is It Time to Take Profits in Walt Disney Co. Stock? originally appeared on Fool.com.

Leo Sun owns shares of Apple, Verizon Communications, and Walt Disney. The Motley Fool recommends Verizon Communications and Walt Disney. The Motley Fool owns shares of Walt Disney. 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.