The wealth-building power of compound interest will never cease to amaze me. But a soft dividend can also distract investors from exciting growth opportunities. There are times when a weak payout may be all right, because the company is building a larger and stronger cash machine to fund payouts in the decades ahead.
Walt Disney (NYSE:DIS) rarely comes up in discussions of brilliant dividend plays. The media giant's measly 1.1% yield is hardly the stuff of legend, and Disney spends just 26% of its free cash on dividend checks. That's less than half the average Dow Jones (DJINDICES:^DJI) cash payout ratio of 57%. With this much headroom to increase payouts, why doesn't the House of Mouse turn up the heat under its dividend policy? Does this company hate shareholders?
The short answer to that rhetorical question is, of course, a resounding "no."
For one thing, Disney is getting over its reluctance to raise dividends lately. Thanks to large increases in 2011 and 2012, Disney's payouts have more than doubled in the last five years. The main reason why this trend didn't unlock a generous yield is simple: The stock is just performing too darn well! It's hard to keep a dividend policy abreast with the rapid rise of Disney share prices.
Moreover, the Mouse has another shareholder-friendly weapon in its arsenal. Disney paid out $1.3 billion as dividends over the last four quarters, but it also bought back $2.4 billion of its own shares (net of new shares printed to power the stock-based compensation program). This is not a new phenomenon. Disney has spent more than $11 billion on net buybacks in the last five years while share prices have doubled. This demonstrates the board and management team's strong confidence that Disney's investments (like the acquisitions of Pixar, Marvel, and Lucasfilm) will pay off. So far, they haven't been wrong.
Buybacks aren't always wise, but I'm willing to suspend my disbelief when it comes to Disney. This company knows how to grow its business and share price by making large cash investments. Holding back some dry powder from the dividend stream seems entirely reasonable when Disney can sink it into a rising stock on one hand and into valuable growth opportunities on the other. Don't stare yourself blind at the low dividend yield when Disney's shares pose a legitimate triple threat.
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