Walt Disney (NYSE:DIS) is one of my core "buy and hold forever" stocks, as I mentioned in a previous article, thanks to the robust appeal of its theme parks, franchises, and media networks. Yet the House of Mouse disappoints investors in one critical area: rewarding its long-term shareholders with a more generous dividend.

Source: Flickr.

Disney currently has a forward annual dividend yield of 1%. That puts its squarely between rivals Time Warner (NYSE:TWX.DL) and Fox (NASDAQ:FOX), which yield 1.6% and 0.7%, respectively. Therefore, let's take a closer look at why it might be time for Disney to raise its dividend.

Why Disney can afford to raise its dividend
When we look at a company's dividend, we should check three main things -- its payout ratio, free cash flow, and return on equity.



















Payout Ratio






Source: NASDAQ.

Disney's payout ratio has traditionally stayed near 20%. At the end of fiscal 2014, Disney is expected to pay an annual dividend of $0.86 per share, which would represent a payout ratio of 18%, based on the average analyst estimate of $4.67 for its full-year earnings. By comparison, Time Warner had a payout ratio of 28% last year, down from 33% in 2011 and 2012. Fox, which split from News Corp. last June while retaining its media segment, had a payout ratio of 13% in fiscal 2014 -- a definite improvement over News Corp's non-existent dividend. 

While investors might be grateful that Disney's payout ratio is at least higher than Fox's, a case can be made for at least matching Time Warner's ratio. To understand why, we should compare the free cash flow (FCF) at all three companies to their respective dividend payments.

DIS Free Cash Flow (TTM) Chart

Source: YCharts.

We can see that although Disney's FCF over the past 12 months was 102% higher than Time Warner's, it only paid out 37% more in dividends. Disney's FCF was also 165% higher than Fox's, yet it only paid out 85% more in dividends.

Investors should also check Disney's return on equity (ROE) to see how efficient the company is at turning invested money into profits. Disney's ROE of 16.7% is higher than Time Warner's 15.6% but lower than Fox's 20.7%. A company with a higher ROE can generally afford to pay out a higher dividend, which means that Disney has more freedom than Time Warner, albeit less than Fox, to boost its payout.

Therefore, I believe it would be reasonable for Disney to boost its payout ratio to Time Warner's level, at around 30% ($1.63 per share based on the consensus estimate of $5.43), in 2015.

Why Disney won't agree
While the case for a higher dividend makes sense, Disney's healthy FCF and ROE allows it to pursue strategic acquisitions like Pixar, Marvel, and Lucasfilm. It also allows the company to build new theme parks, cruise ships, and nurture its existing franchises. Tying up too much of its FCF in dividends could hamper its ability to do so.

Moreover, paying out large dividends is generally how mature, lower growth companies compensate for a lack of growth. Disney stock climbed 31% over the past 12 months -- easily outperforming Time Warner, Fox, and the overall market by a wide margin.

DIS Chart

Source: YCharts.

Disney will also keep growing its core business segments with the release of Star Wars: Episode VII, a seemingly endless stream of Marvel movies and shows, robust growth in its cable networks, and the grand opening of Shanghai Disney Resort next year. This means Disney could reward shareholders with strong price growth rather than dividends.

Another common request is that Disney pay its dividends quarterly, instead of annually as it has done since 1999. However, retaining an annual dividend encourages long-term investing by discouraging investors from dumping the stock after the ex-dividend date.

Is a big dividend boost on the horizon?
Investors shouldn't expect Disney to be like Altria (NYSE:MO), which pays out 90% of its earnings, but they should get a slightly better payment that at least matches Time Warner's payout ratio. However, that's unlikely to happen unless Disney's management runs out of acquisitions to make and new movies to produce. For now, investors shouldn't fret about Disney's small dividend, and should instead focus on the major catalysts on the horizon. After all, while Disney pays a smaller dividend than its peers in relation to its earnings, it does possess dozens of one of a kind properties that should make Disney a long term winner for investors regardless of its dividend.