Investors are fired up about Walt Disney (NYSE:DIS) right now, and there’s plenty to like about the stock. Parks are set to reopen as pandemic-related restrictions are lifted. Disney+ is a powerhouse with nearly 150 million subscribers and multiple shows that have grown extremely popular.
Importantly, the shift to a streaming subscription model produces more stable cash flows, which is important following years of cord-cutting threatening revenue from other Disney properties such as ESPN. Over the past year, the stock has popped 92%, outpacing the S&P 500 by more than 30 percentage points.
That’s a tempting narrative sure to attract bullish investors, but you might struggle to choose between loading up on Disney shares or following a more balanced approach by holding an S&P 500 index fund. Before deciding one way or another, make sure that you know the pros and cons of each option, and how they relate to your specific circumstances.
The pros and cons of diversification
It’s one of the great investing cliches but diversifying your portfolio will deliver some real benefits. Investing necessarily requires us to make some predictions, but it’s smart to understand our limitations. Making a large bet on the success of a single company exposes your portfolio to the risk that something unexpected wipes out your savings (or at least drags on your returns). It’s happened time and again — scandals, poor governance, rapid market disruption, or plain old competition have blindsided investors by negatively impacting corporate financial performance.
Diversifying dilutes this risk. By owning a large number of stocks, you can stake your performance on the results of an entire economy, sector, or industry. An entire index is far less likely to falter than a single company. A diversified portfolio is also less volatile than a single stock, so you might be able to achieve similar returns without enduring such large price fluctuations. You should be compensated for the risk you take on, so volatility is an important consideration.
That’s all great, but active, high-conviction investors correctly point out that diversification also dilutes upside potential. If you own 10 stocks that all outpace the market, but one that far exceeds all others, then you incurred opportunity cost on any dollar that wasn’t directed to the biggest winner.
There’s some balance to be struck here, depending on your circumstances, level of sophistication, and tolerance for risk. For the majority of investors, it’s smarter to own a whole index rather than a single constituent stock. We need to dig into the specifics of Disney to be sure in this case.
Growth and risk for Disney investors
Investors can generally expect S&P 500 annual earnings growth of 5% to 7% on average, and Disney looks set to outpace that over the medium term, based on consensus forecasts. The company is looking to rebound from a very difficult 2020 and enter a new era led by its highly successful streaming content distribution platform. From a growth perspective, Disney certainly delivers more upside potential than the S&P.
The stock’s beta value has been 1.21 over the past five years, so it quantifiably entails more volatility and risk than a portfolio composed of the entire S&P 500. That’s to be expected and is consistent with the usual differences between individual stocks and diversified portfolios. However, investors should understand that Disney shares will almost certainly have a steeper drawdown than the benchmark index if there’s a bear market. Disney trades at more than a 38 forward price-to-earnings ratio. That’s not particularly high, and it’s very close to streaming rival Netflix (NASDAQ:NFLX), but it is a bit higher than the large-cap value stocks that typically don’t experience as much volatility.
Times are uncertain. Interrupted pandemic recovery efforts or rising interest rates could cause the stock market to falter over the next year. If you want to focus on Disney rather than an index, be aware of this potential risk.
So which is a better buy?
Disney is a better bet for midterm growth, but it might not be wise to invite excessive volatility into your portfolio at a time with such high valuation ratios and so much uncertainty. If you’re a Disney bull with high risk tolerance and a long time horizon, then that stock is a more appropriate buy alongside a handful of other stocks. For most people, indexing is a much more suitable strategy.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
View more information: https://www.fool.com/investing/2021/03/31/better-buy-disney-stock-or-every-sp-500-stock/