Disney (NYSE:DIS) stock has a dividend yield of around 1.5%. This rate trails the average for the S&P 500 of around 2.1%, but it's a positive sign for investors looking to invest in a great company that has the potential to be a leading dividend payer in the years to come.
Why so low? Part 1: stock appreciation
Dividend yield is the annual dividend payout divided by the share price. A rising or falling yield, on its own, doesn't provide investors with enough information to determine if a stock is a good dividend investment. A falling share price, caused by a deteriorating business, will lead to a higher yield. The payout may be cut or eliminated, and the high yield will vanish with it.
Disney's yield is a victim of the company's success. Over the past five years, Disney stock has more than doubled the return of the S&P 500. Had the stock's performance matched the index it would be yielding over 3%, but the payout -- cash deposited into investors' brokerage accounts -- would be the same.
This is a high-class problem, and I'm sure investors are happier with the status quo than with the alternative reality. It just goes to show that a stock can be a great dividend payer even if it doesn't show a yield above the average for many years. If Disney stock were to grow at 15% annually over the next five years, it would probably outpace the market and would double in value. If management were to increase the dividend payout by 10% annually over the same period, the yield would drop. Nevertheless, investors would be receiving annual dividend payments about 60% greater than what they receive today. You don't have to buy a high yielder to get a great payout.
Why so low? Part 2: Better opportunities
Another reason the yield is so low is that management has had better uses for the cash. Disney's payout ratio is only 25.6%, which means the company allocates just over a quarter of its earnings to pay dividends. This is an extremely conservative payout ratio. Disney could double the dividend tomorrow and still be able to comfortably raise the dividend each year going forward. As long as a management team has proved itself to be a good capital allocator -- more on that in a second -- this low payout ratio is a very good sign.
A business can generally do three things with its earnings. It can grow the business through reinvestment or acquisition, pay a dividend, or repurchase and retire its own shares. If Disney's management was constantly buying back shares at overvalued prices and making destructive acquisitions, I would prefer this payout ratio to be closer to 75% than 25%. The great brands and products Disney has would bring in cash every quarter, and management would be prevented from doing anything too stupid with it.
This is not the case with CEO Bob Iger, who has been an excellent steward over shareholder capital. The acquisitions of Pixar, Marvel, and Lucasfilm have already proved to be great purchases and will bear fruit for shareholders for decades to come. Large capital investments into theme parks such as Shanghai Disney and the Star Wars park at Disneyland will have ROIs that justify not paying out more in dividends now. In short, $4 billion was better spent buying Marvel then it would have been in shareholders' pockets back in 2009.
Why the future is bright
Disney is a great company. It generates earnings from films, theme parks, licensing agreements, television, and other media properties. Management is excellent -- Iger is signed up though mid-2018, and his heir apparent, Tom Staggs, is the current COO -- and has shown a deft touch with acquisitions. The dream scenario for shareholders would be that they find 10 more Pixars and Marvels out there, buy them, and continue to grow the earnings power of the business.
At some point this will become more difficult, perhaps impossible. It will then be prudent for management to increase the payout ratio, and/or aggressively repurchase shares (depending on valuation at the time). Net income will almost certainly have increased significantly by the time this happens. A higher payout ratio, coupled with increased earnings, will lead to dividend payments that dwarf what shareholders currently receive.
Enjoy the growth at Disney for as long as it lasts. If compelling reinvestment opportunities are no longer available, this cash-cow business will turn its focus toward dividends and investors will be rewarded once again. Disney is a core holding in my portfolio, and I recommend taking a deeper look to see how it might fit in yours. Don't let the yield scare you away from a great dividend investment.
James Sullivan owns shares of Walt Disney. The Motley Fool owns shares of and recommends Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.