Whether you revere it as The Paper of Record or revile it as a mouthpiece of the liberal left, there's no denying that Motley Fool Income Investor selection New York Times (NYSE:NYT) has been hugely successful in writing, selling, and occasionally creating headlines over the past 156 years.

In addition to its flagship publication, the company owns the Boston Globe, International Times Herald, more than a dozen regional newspapers, and almost three dozen websites. It made headlines anew this past week, when it announced a 31% increase its quarterly dividend, to $0.23 a share. The boost upped Times' yield by nearly a full percentage point, to 3.9%. While market warmly welcomed the higher dividend at first, it might not serve shareholders' best interests in the long run.

Reading between the lines
Times' huge payout boost represents a marked shift in the firm's strategy for returning value to shareholders. "This dividend increase, which is another important step in creating value for our shareholders, puts our dividend yield and payout ratio significantly above that of the S&P 500 and others in our industry," said Chairman Arthur Sulzberger, Jr.

Sulzberger ain't just whistlin' "Dixie." Let's compare the new higher-payout strategy with both its predecessor and the S&P 500. I'll normalize 2006 earnings to back out a mammoth one-time charge the company took this past year on its Boston Globe and Worcester Telegram & Gazette investments.

Dividends / Earnings

Dividends / Free Cash Flow

Dividend Yield

Old Strategy

52.8%

113%

3%

New Strategy

69.2%

148%

3.9%

S&P 500

30.8%

35.1%

1.8%
*Data gathered from Standard & Poor's website, and from Capital IQ, a division of Standard & Poor's.

At first blush, these figures certainly seem less than heartwarming for those hoping for further dividend hikes. In 2006, the firm spent $358 million on capital expenditures, substantially greater than its historical norm. Of that spending, $192 million went toward the company's portion of the expenses on its new corporate headquarters. The firm plans another $340 million to $370 million in capex next year, including another $170 million to $190 million for its new headquarters, and $75 million toward plant consolidation. Surely I can't be the only person wondering why these guys are spending so much money on fancy new digs instead of improving their operations?

I'm not. Since mid-2005, Hassan Elmasry, a London-based Morgan Stanley (NYSE:MS) portfolio manager, has led a campaign pressuring the Sulzberger family to remove the dual-class share structure that grants the Sulzbergers disproportionate control over Times' board. In a presentation to the board last month, Elmasry personally delivered his grievances regarding the share structure and the swanky new corporate headquarters. Elmasry's pushing doubtlessly influenced the board's decision to hike its dividend, a very shareholder-friendly move, in the board's opinion.

I'm not exactly wild about dual-class structures such as these, nor the company's spending on its new headquarters. More importantly, though, I'm concerned about the fundamental long-term viability of the company's publishing operations, given the Internet's growing popularity in providing news, job postings, and classified ads.

Hoping to adapt with the times, the company is working to scale its hard-copy content onto the Web. It also plans to continue ramping up its 2005 acquisition and company golden child, About.com. The online division's operating margins are fat, but they only represent a small piece of Times' overall pie. Despite anticipated 30% growth in online revenues in 2007, the division will only contribute about 11% of analysts' estimated 2007 total revenues. I have doubts that the firm can shift its focus smoothly, and at least some of its online offerings may ultimately flop.

Getting back to the dividend...
Additional liquidity is on the way as Times sells off its broadcast media group, a portfolio of nine television stations, for slightly more than half a billion dollars. I like the move; it shifts the company's focus closer to its core competency while providing a welcome cash infusion.

Still, I'm concerned about the limitations a higher payout will put on Times' admittedly low growth. Will it generate enough free cash flow to pay that dividend consistently? The cash made from selling the broadcast group should leave the dividend on safe footing, but shareholders had better savor this latest hike. It'll probably be the last significant one they see for a long time.

Dividend School
Speaking of long-term dividend growth, this seemed liked a great time to discuss one of my favorite dividend-focused equations. Yes, I have favorites. Stop snickering. This one's used to predict the future growth rate of a firm's dividend (and often its expected earnings growth, too). Here's how it goes:

Expected Dividend Growth Rate = Return on Equity * (1 - Payout Ratio)

The equation assumes a constant ROE and payout ratio. It implies that if a firm's ROE decreases, its ability to grow dividends will suffer. Conversely, if a firm improves its ROE, its dividends stand to rise. It's also implicit that firms with low payout ratios will grow their dividends more quickly than those already paying out a substantial percentage of their earnings.

How does this shake out for our friend New York Times? Based on its new payout structure, and after normalizing earnings to reflect last year's write-off, I calculate its expected dividend growth rate as follows:

20.5% * (1 - 69.2%) = 6.3%

How does the Times stack up against its media brethren?

Company

Return on Equity

Payout Ratio

Expected Dividend Growth Rate

Motley Fool CAPS Rating

Gannett (NYSE:GCI)

14.6%

24.1%

11.1%

*

Washington Post (NYSE:WPO)

11.3%

23.1%

8.7%

***

McClatchy (NYSE:MNI)

7.9%

21.8%

6.2%

*

Ironically, the stock with the highest ROE and expected dividend growth rate, Gannett, has a one-star Motley Fool CAPS rating. A quick look at Gannett, best known as the publisher of USA Today, shows the same situation facing other major newspaper publishers: declining gross margins and profitability, but an intriguing valuation. Despite the newspapers' declining fundamentals, Gannett's yield of 2.2% and forward P/E of only 12 could make it worth digging into.

Further reading
I hope you enjoyed this week's column. As always, I welcome your feedback. Dying for more dirt on dividends? Check out a free 30-day trial to James Early's Motley Fool Income Investor newsletter. Still want more? Read last week's Weekly Dividend, or a couple of other Foolish dividend-focused articles from the past week:

Foolish editor Joe Magyer wishes more restaurants in Alexandria served sweet tea. Joe does not own any stocks mentioned in this article but notes that New York Times is an Income Investor pick. Joe's holdings and CAPS profile are always available for your viewing pleasure. The Motley Fool has a disclosure policy.