Disney Needs To Rethink Dividend Policy

| About: The Walt (DIS)

There are certain things we come to expect of American blue-chip stocks. We expect them to have strong brand names, stable earnings, long-term profit growth, and a consistent quarterly dividend payout that grows with time. Of course, some tech companies like Google (NASDAQ:GOOG) or Apple (NASDAQ:AAPL) may be an exception because they think it is in the shareholders’ interests for management to retain earnings to fuel higher growth, but the general rule-of-thumb holds true: The best stocks in the large-cap universe tend to be the blue chips that raise their quarterly payouts every year, allowing the investor to accumulate an ever-growing stake in the business.

One notable company that fails to act like a blue-chip stock is The Walt Disney Company (NYSE:DIS). Disney walks, talks, and acts like a blue-chip, but it doesn’t have a dividend to match it. Disney doesn’t pay out a quarterly dividend; in 1999, Disney decided to pay out an annual dividend every March. Right now, the dividend stands at $0.40 per share. That gives investors at current prices a yield slightly above 1% -- not exactly a formula for long-term wealth building.

It seems that Disney fell into believing that investment gains would come from capital appreciation, not steady dividend increases. During the secular bull market of the 1980s and 1990s, it is understandable why this would be the case. Disney stock soared into the $100 range multiple times during this stretch, and Disney’s board of directors authorized a 4:1 stock split in 1986, 4:1 in 1992, and 3:1 in 1998. It seemed to be a nice formula: Let the stock triple or quadruple in price, do a stock split, and then do it all over again. Who needs dividends when your stock price is always climbing higher?

But of course the stock price flatlined during the past decade, and shareholders haven’t been able to enjoy a steady stream of dividend payments to serve as an income bulwark in a sideways market. If Disney had offered a 3-4% dividend in this investment climate, it would have enabled shareholders to get in at lower prices, significantly boosting returns. Also, dividends have a peculiar way of putting a price floor on a stock if the company’s future ability to grow earnings and maintain dividends is not in question.

Many income-oriented, dividend-growth, and retiree investors won’t even look at Disney’s stock because of its paltry annual payout. Even if Disney didn’t raise its payout and instead shifted to quarterly $0.10 payments instead of an annual $0.40 check, it would at least lay the groundwork to get the attention of potential investors.

Disney has $12 billion in debt, but it also has a remarkably diverse stream of earnings. DIS operates major media networks such as ABC and ESPN, owns Disney Parks & Resorts, Disney’s Hollywood Studios, and Disney’s cruise line. Warren Buffett once remarked that Disney was like an oil company that could put oil back in the ground, citing the company’s ability to generate significant income from movies, put them in the vault, and then repeat the process a decade later.

Disney currently has generated $2.36 in trailing 12-month earnings. Disney's $0.40 annual payout amounts to just under 17% of earnings. That’s pitiful. If Disney wants to perform well in a stagnant market, it ought to pay out half its earnings as dividends. That ought to give it enough of a cushion to maintain its dividend in the event of a further economic downtown. If Disney paid out half of its earnings, it would have an annual $1.18 payout. That would give Disney shareholders $0.295 per share each quarter. At today’s current prices, that would give investors a 3.7% dividend yield, a meaningful amount to allow investors to compound during a down market. Most of the stock market’s historical returns have come from dividends, and a 17% earnings payout is an insult to current investors. Disney’s stock movement hasn’t been impressive this decade, and the initiation of a significant dividend payout might be the perfect medicine for the House of Mouse.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.