Microsoft Corporation (MSFT, Financial) has raised its dividend for 20 consecutive years, so the company has shown a commitment to growing its dividend for a long period of time. This growth has been fueled by its market leadership in its industry, which has provided ample capital to return to shareholders through dividends.
Looking closer at the company, it seems that Microsoft’s dividend growth should be secure for years to come. This article will examine why I believe that Microsoft’s dividend growth is still in the early innings.
Company background and results history
Microsoft has a market capitalization of close to $2.2 trillion, making it one of the largest companies in the world. The company has reached this level of value because of its leading position in its area of the economy. Microsoft is the largest independent provider of software that is used in a whole host of end-markets. The company also has a top position in the area of cloud computing. In addition, the company also sells laptops, tablets and video game systems. Microsoft has annual revenue in excess of $168 billion.
Microsoft reported earnings results for its second quarter of fiscal year 2022 on Jan. 26 (the company’s fiscal year concludes June 30). Revenue was up more than 20% to $51.7 billion while adjusted earnings per share of $2.48 compared to $2.03 in the prior year. Both figures were well ahead of what Wall Street analysts had anticipated.
Strong growth rates aren’t uncommon to the company. Microsoft's annual revenue has more than doubled over the last decade. Top-line figures have a compound annual growth rate (CAGR) of 9.6% for the last 10 fiscal years.
Earnings per share have a CAGR of 12.8% over this same period. A slightly lower share count helps in this area, but Microsoft has also improved its net profit margin from 31.4% in fiscal year 2012 to 36.5% last fiscal year.
The medium-term figures are even better. Revenue and earnings per share have CAGRs of 14.8% and 27.1% over the last five years, respectively. This is largely due to the substantial increase that cloud computing has had on the business.
Growth doesn’t show signs of slowing either. Wall Street analysts expect that Microsoft will generate revenue of $198.8 billion and earnings per share of $9.44 this fiscal year. This would represent 18.2% and 17.3% improvements from the previous fiscal year, respectively.
Dividend growth history and recession performance
Technology is not typically a sector that performs well during a recession as demand can soften as the economy enters a downward spiral.
Microsoft is not your typical company though. The following are the company’s adjusted earnings per share before, during and after the 2007 to 2009 period of the Great Recession:
- 2006 adjusted earnings per share: $1.20
- 2007 adjusted earnings per share: $1.42 (18.3% increase)
- 2008 adjusted earnings per share: $1.87 (31.7% increase)
- 2009 adjusted earnings per share: $1.62 (13.4% decrease)
- 2010 adjusted earnings per share: $2.10 (29.6% increase)
- 2011 adjusted earnings per share: $2.69 (28.1% increase)
Microsoft’s earnings per share did see a decline from 2008 to 2009, but still managed to grow 14% during the Great Recession. Even accounting for a reduction of close to 500 million shares, Microsoft’s net profit grew more than 8% from 2007 to 2009. The years following the recession also showed growth. Except for two years early last decade, the company’s earnings per share have been in an uptrend, especially over the past five years.
The company also continued to grow its dividend during the Great Recession, with a total increase of 30% for the time period. This shows that the dividend is likely to continue to grow even in tough environments.
More recently, Microsoft has navigated the Covid-19 pandemic well. In fact, the company took advantage of the transition to the work-at-home environment that occurred in 2020. Revenue grew almost 14% while net profit was up more 20%.
Microsoft has proven itself successful at growing despite the circumstances of the market, which is a benefit of being as entrenched in its industry as the company is. The dividend grew nearly 10% in 2020 as well.
Shareholders received a 10.7% dividend increase for the Dec. 9, 2021 payment date. This is very close to the 10-year CAGR of 12.1%, demonstrating just how consistent Microsoft has been at raising its dividend over the long-term. Dividend growth tends to slow as the dividend becomes larger in size. This hasn’t been the case with Microsoft.
The stock may not yield much, just 0.8% as of the most recent close, but the dividend is unlikely to be cut because it is so well covered.
Payout ratios impact on future dividend growth
In fiscal year 2021, Microsoft distributed $2.24 of dividends per share while adjusted earnings per share totaled $8.05. This equates to a payout ratio of just 28%.
Shareholders will receive $2.42 of dividends per share this fiscal year, resulting in a projected payout ratio of 26%. Both figures are well below the 10-year average payout ratio of 40%.
The free cash flow payout ratio is also extremely low. Over the last year, Microsoft paid out $17.3 billion of dividends while producing free cash flow of $60.7 billion for a payout ratio of 29%. The average for the prior four years was just 34%.
Microsoft’s dividend looks very safe using either earnings per share or free cash flow and leaves considerable room for the company to continue to grow its distribution at a very high rate.
The impact of debt on dividend security
One last item to consider is the company’s debt. Specifically, will obligations hinder Microsoft’s ability to continue growing its dividend?
Microsoft has had interest expense of $2.25 billion over the last 12 months. Total debt was $64 billion at the end of the most recent quarter, giving the company a weighted average interest rate of 3.5%.
The excel chart below shows where the company’s weighted average interest rate would need to be before dividend payments were no longer covered by free cash flow.
Source: Author’s calculations
The chart above shows that Microsoft’s weighted average interest rate would need to reach above 71.2% before dividends would no longer be covered by free cash flow. This is one of the highest figures of all the companies that I follow. Given this, there is a very low probability of debt obligations impacting the company’s ability to continue to pay dividends to shareholders.
Valuation analysis
Despite all that the company has going for it, shares trade very near to their intrinsic value according to the GF Value chart.
Microsoft has a GF Value of $279.64, which gives the stock a price-to-GF-Value ratio of 1.06. As you can see, shares haven’t been this close to the fair value line in some time. This earns the stock a rating of fairly valued from GuruFocus.
Final thoughts
Microsoft has many qualities that dividend growth investors are looking for, including a dominant market position, a dividend that appears to be extremely safe and a lengthy and consistent track record of raising distributions.
These factors also make it likely that Microsoft’s dividend growth should continue to be close to the long-term average. This suggests that investors looking for a high-quality technology name still in the early innings of growing its dividend may want to consider Microsoft.
