Dividend Stock Investors: Don't Underestimate Disney

By Markets Fool.com

Image source: Disney.

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When thinking about the best dividend stocks in the market, Disney (NYSE: DIS) is not a name that typically comes to mind. After all, the stock pays a modest dividend yield of only 1.5% at current prices. However, make no mistake: Disney is poised for massive dividend growth in the years ahead, and this is a crucial consideration to keep in mind.

Growing dividends from Disney

In June of last year, Disney changed its dividend payment schedule. The House of Mouse went from paying annual dividends to distributing payouts on a semi-annual basis. In addition, the company raised dividends by 15% versus the same period in the prior year. This increase in June 2015 came after raising payments by 34% year over year in December 2014.

Disney isn't wasting any time when it comes to dividend growth over the middle term: What was a dividend payment of only $0.35 annually per share in 2009 has now increased to $1.42 per year and growing at full speed.

Importantly, the company has substantial room to continue raising dividends in the future. Wall Street analysts are on average forecasting that Disney will make $5.79 in earnings per share this year, meaning that the dividend payout ratio is comfortably low, in the neighborhood of 24.5% versus earnings expectations.

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The business behind the dividend

The entertainment industry is quite cyclical, as the sector is particularly sensitive to economic conditions and changing discretionary spending through the business cycle. However, Disney is no average company in the entertainment industry: Brand differentiation, intellectual properties, and unparalleled financial and strategic resources make of Disney one of a kind.

The company has delivered consistent profitability through all kinds of scenarios. Even during the financial crisis and the ensuing Great Recession in 2008 and 2009, Disney still managed to produce positive earnings and free cash flows figures. Financial resiliency, of course, is a key aspect to consider when analyzing a company and its potential for dividend growth.

The networks division has been under pressure lately, as consumers are moving away from traditional cable TV toward online streaming services. However, the business is still doing better than fine on a global scale. Total revenue during the quarter ended in June increased 4%, while segment operating income grew 10%, and free cash flow increased 12% year over year.

Why you should invest in dividend growth stocks

Smart dividend investing is about much more than focusing on companies with big dividend yields. It's of the utmost importance to pay close attention to a company's trajectory of dividend payments and its ability to continue increasing dividends in the future.

Companies with consistent dividend growth over the years need to generate more than enough cash flows to reinvest in the business and also reward investors with increasing cash payments. Doing these things says a lot about the company's financial health and its business quality.

Moreover, if management believes the company will face problems in the future, then it will most probably accumulate cash reserves, as opposed to distributing that cash to investors. So vigorous dividend growth can be interpreted as a sign of confidence from the management team on the future of the business.

There is no infallible formula to beat the market, but statistical studies have proved that dividend growth stocks tend to outperform in the long term. According to data from Ned Davis Research and Reality Shares Research, companies raising their dividends every year or starting new dividend payments delivered an annual return of 9.84% from Jan. 31, 1972, to June 30, 2016. Over the same period, companies with stable dividends produced an annual return of 7.26%, and companies with no dividend payments delivered a smaller return of 2.34%. Unsurprisingly, companies cutting or eliminating their dividends produced a negative return of 0.55% per year in the period under analysis.

Historical evidence indicates that buying companies with consistent dividend growth can be a smart strategy to maximize returns. Disney doesn't offer much in terms of dividend yield, but the company has both the willingness and the ability to deliver strong dividend growth in the years ahead, and this could be a powerful return driver for investors.

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Andrs Cardenal 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.