Walt Disney (DIS -0.83%) is in the middle of a buyback binge right now. The House of Mouse has spent $6.5 billion on retiring its own shares over the last year alone. That's a 58% increase year over year, and very close to Disney's all-time record buyback levels.
Does this massive buyback make sense, or should Disney find something better to do with some of this capital?
Bob Iger, Walt Disney's CEO since 2005. Image source: Disney
Let's consider the evidence
First, let's hear from Disney CEO Bob Iger. In an earnings call from August 2013, just before this buyback spree kicked off, Iger explained how his company thinks about capital management.
Our belief is that a lot of the capital investment we have been engaged in, particularly in parks and resorts over the past three or four years plus the deployment of capital in acquisitions, will yield returns such that we will have the great problem of dealing with increasing cash flow as the years go by.
We look very hard for internal and organic ways to invest our capital above our rate of return. We think that's why our investors give us their money to invest.
That being said, we are not departing from kind of the formula we have used in returning capital to shareholders, where we have consistently returned 20% or so of the cash generated by the company to shareholders in terms of buybacks.
Iger was using "20% or so" very loosely here. At the time, Disney had spent 40% of its operating cash flows year to date on buybacks. In 2014, that ratio has ballooned to 76%. Seen from a different angle, Disney is spending 116% of its free cash flows on share repurchases.
Meanwhile, Disney shares are trading near all-time highs. The stock has gained 36% over the last year, and these buybacks have only reduced the diluted share count by 4%. Like Iger's "great problem of dealing with increasing cash flow," it's always good to see shares rising on organic business strength.
But I'm shaking my head at the idea of pouring billions of dollars into record-level buybacks when share prices are on a tear to begin with.
Here's a better idea: Stronger dividends
I understand that Disney wants to return excess cash to shareholders, and I applaud the effort as an owner myself. But why not use these funds to boost Disney's anemic dividend policy instead?
While shoveling $6.5 billion into the buyback effort, Disney only spent $1.5 billion on dividends over the last 12 months. The dividend yield sits at an even 1%, far below the 2.8% average yield among the 30 Dow Jones Industrial Average (^DJI -0.12%) members.
Now, Disney isn't exactly sitting still on the dividend front. The company is, in fact, increasing its payouts about as quickly as share prices keep rising. Another nice problem to have: steadily rising share prices.
And I get that sudden dividend windfalls do little to help investors. Backing down from a period of rampant payout increases tends to be bad for share prices, to say nothing of actually reducing a dividend under financial pressure.
So I'm not looking for anything crazy here. No need to move the $6.5 billion annual budget into the dividend column, switching places with the buyback effort. But I wouldn't mind at all if Iger and his team doubled the dividend budget next year while holding back on the share repurchases.
That way, Disney's dividend yield would still be modest by market standards but significantly more generous than it is today. The $3 billion dividend budget should be easy to defend for years to come, especially since Iger is looking for larger cash flows to feed it from.
And please, pretty please, stop the buyback madness. Keep the repurchases to a token effort, do more than just keep the dividend apace with soaring share prices, and enjoy the lack of wasted capital.
Because that's exactly what big buybacks can be when the market isn't right.
