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Key Things To Consider Before Buying The Walt Disney Company (NYSE:DIS) For Its Dividend

Simply Wall St

Is The Walt Disney Company (NYSE:DIS) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

A slim 1.2% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Walt Disney could have potential. Some simple analysis can reduce the risk of holding Walt Disney for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Walt Disney!

NYSE:DIS Historical Dividend Yield, February 13th 2020

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Walt Disney paid out 31% of its profit as dividends. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Plus, there is room to increase the payout ratio over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. With a cash payout ratio of 263%, Walt Disney's dividend payments are poorly covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. While Walt Disney's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to Walt Disney's ability to maintain its dividend.

Is Walt Disney's Balance Sheet Risky?

As Walt Disney has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Walt Disney has net debt of 2.56 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Walt Disney has EBIT of 9.64 times its interest expense, which we think is adequate.

Consider getting our latest analysis on Walt Disney's financial position here.

Dividend Volatility

From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. Walt Disney has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was US$0.35 in 2010, compared to US$1.76 last year. Dividends per share have grown at approximately 18% per year over this time.

It's rare to find a company that has grown its dividends rapidly over ten years and not had any notable cuts, but Walt Disney has done it, which we really like.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Earnings have grown at around 5.5% a year for the past five years, which is better than seeing them shrink! Earnings per share have been growing at a credible rate. What's more, the payout ratio is reasonable and provides some protection to the dividend, or even the potential to increase it.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. First, we like Walt Disney's low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. Earnings growth has been limited, but we like that the dividend payments have been fairly consistent. Ultimately, Walt Disney comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 27 analysts we track are forecasting for Walt Disney for free with public analyst estimates for the company.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.