Microsoft's Dividend To Double By 2016

| About: Microsoft Corporation (MSFT)

Microsoft (NASDAQ:MSFT) recently announced a plan to boost their dividend by 22% to 28 cents per quarter, and this will just be the beginning. While the new dividend increase was 3 cents higher than analysts were expecting, it likely pales in comparison to future dividend increases, which will be announced within the next few years. In this article, we will explore Microsoft's balance and income statements as well as current management plans to explain why Microsoft will likely increase its dividend by over 100% in the next two years.

The Path to Higher Payout

Microsoft had earnings in 2013 of almost $22 billion. Total cash from operating activities was just shy of $29 billion. Management has been working actively on their share buyback program and have been able to reduce the outstanding common shares by 340 million shares since 2010. Microsoft's strong income growth combined with their share repurchases have helped the company increase earnings per share from $1.62 in 2009 to $2.58 in 2013. With the recently announced $40 billion share buyback, Microsoft will potentially be able to repurchase about 1 billion of their current outstanding shares. Microsoft had a total dividend payout in 2013 of $7.455 billion. If we assume that the company simply wanted to maintain the same payout in the future and consider that there will be 12.5% fewer shares after the buyback, then Microsoft will mathematically have to raise the dividend by about 10 cents per share on a yearly basis.

Payout Ratio

The chart below shows Microsoft's payout ratio for the last few years.

Over the last two years, we can see that Microsoft has been increasing its payout ratio. This could perhaps be because the company is having trouble effectively using its large cash reserve to drive further growth, whether it be through acquisitions or internal projects. It could also be that Microsoft is looking to drive its share price higher by increasing its overall dividend yield. This has certainly helped drive shares higher in the last 2 years, as Microsoft has finally broken out of a decade long trading range and has reached a high not seen since the year 2000.

Furthermore, when compared to other large tech companies such as Texas Instruments (NYSE:TXN), Intel (NASDAQ:INTC) and Broadcom (BRCM), Microsoft has a payout ratio, which is below average. Although it has climbed in recent years, Microsoft still has a lot of room to go in expanding its payout ratio.

Expectations

Microsoft's continued earnings growth and a strong buyback program will drive earnings per share higher at an accelerated rate. Microsoft will also continue making an effort to boost its payout ratio so it can be more in line with other large tech companies. This will force Microsoft to directly boost the dividend on a yearly basis simply to maintain the same nominal payout level, which it is currently offering. Considering these factors and taking into account analyst earnings estimates for Microsoft, we can estimate the future dividend payments for Microsoft in the years to come.

Considering the following estimates and assuming a future payout ratio of 45%, we can calculate the future yearly dividend payments as follows.

Under the above conditions, Microsoft can be expected to have a yearly dividend payment in 2016 of about $1.50, or a quarterly payment of 37.5 cents. This would represent an increase of 34% over the current dividend. However, I strongly believe that analysts are underestimating Microsoft's future dividend potential and I think that it is likely that Microsoft will be able to raise its dividend rate to 50 cents per quarter by 2016.

Future Management to Boost Profits

Over the last few years, Microsoft's profit has taken a dramatic hit from non-core business lines such as the highly costly Bing search business and the money bleeding Xbox division. It is estimated that Microsoft's online services division has lost a total of $10.9 billion since 2005 and $1.3 billion in 2013. Furthermore, in the last year Xbox has lost over $2 billion for the company. If these two divisions were cut, Microsoft would almost instantly see its profits increase by more than $3 billion per year. And that is exactly the plan of action, which I think Microsoft will take in the next 12 months.

Mr. Stephen Elop, the front runner to replace Steve Ballmer as Microsoft CEO has stated that he would make some big changes if he got the top job at Microsoft. Elop's main goal would be to streamline the company and focus on promoting Office in order to promote growth. The Xbox division would be sold off or perhaps spun off into an independent company potentially worth almost $17 billion. The Bing search engine would be eliminated. Furthermore, Elop is widely expected to cut a substantial number of jobs at Microsoft as he searches to increase profits and return on equity.

Conclusion

With the cost cutting and income growth expected under new management, Microsoft will be able to greatly increase profits in the years to come. It would not be unlikely for earnings per share to be higher than $4 by 2016. Considering also that Microsoft will be actively working to reduce its outstanding share count as well as increase its payout ratio, a common dividend of at least 50 cents per quarter is absolutely possible. This would represent a doubling from Microsoft's 2013 dividend payout of 97 cents per share.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.