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Summary

  • Microsoft sports a dividend yield of 2.7% and a market cap of $349 billion.
  • Given the strong dividend coverage ratio, dividend growth could approximate 15% annually for the next two years.
  • Microsoft's strategy will require substantial investment in datacenters and other infrastructure to support devices and services.

The scope of this article will look at the financial health of Microsoft (NASDAQ:MSFT), and the ability to continue to pay the dividend. The continued growth of the company, the powerful business model and the ability to raise the dividend mandates that dividend growth investors give this stock another look.

How Safe is the Dividend?

Cash flow summary ($ in billions)

Nine Months Ended 3/31/14

Nine Months Ended 3/31/13

Cash from operations

$22.7

$22.9

Capex

($4.2)

($2.5)

Proceeds from issuance of debt

$8.9

$2.2

Repayments of debt

($1.9)

0

Repurchases of common stock

($6.1)

($4.3)

Dividends paid

($6.6)

($5.5)

The cash balances at 3/31/14 was $11.6 billion, and the company also had short-term investments of $76.9 billion as of that same date. The short-term investments are primarily U.S. government and agency securities and corporate bonds and notes.

For the most recent nine months, MSFT generated $18.5 billion in adjusted free cash flow, or cash from operations minus capex. The dividend coverage ratio is the free cash flow over the dividend, or 2.8x.

For more comparisons on other large cap dividend coverage ratios, see this article on AT&T (NYSE:T) or this article on Disney (NYSE:DIS). Please note that Starbucks (NASDAQ:SBUX) had a dividend coverage ratio of 3.3x for the most recent six months of operations, and I concluded that this dividend would be raised in the next couple months.

The Downside of an Investment in Microsoft: Stiff Competition

Now an investment in MSFT is not fool proof. Microsoft faces major competition from firms that provide competing platforms and applications. These competitors include Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), and Google (GOOG, GOOGL). I looked at some of the competitive strengths of Amazon in this article.

The strategic importance of developing a strong ecosystem increased with the launch of the Windows 8 operating system, Surface, Windows Phone, Xbox, and associated cloud-based services.

Windows 8 was designed to unite the light, thin, and convenient aspects of a tablet with the power of a PC. The Windows 8 operating system includes the Windows Store, which offers applications from Microsoft and partners for both business and consumer customers.

In some cases, Microsoft builds its own devices, such as Xbox and Surface. Xbox One was released on November 22, 2013.

Bear in mind that competitors in smartphones (Apple and Google) and tablets have established significantly larger user bases. These competing platforms have applications marketplaces (sometimes referred to as "stores") with scale on mobile devices. These applications leverage free and user-paid services that over time result in disincentives for users to switch to competing platforms. In order to compete, MSFT must successfully enlist developers to write applications for the marketplace to ensure that these applications have customer appeal and value.

While most people still know Microsoft as "the Windows company," the old Windows guard no longer drives its business. The look of Microsoft's entire software line has been led by a group that came from the mobile device division.

Microsoft peddled a grand computing vision for a long time and struggled mightily to make it happen. While the company championed mobile devices no one wanted, Apple became the most valuable company in the world on the back of the iPhone and iPad. Google, too, outflanked MSFT through its Android software.

Conclusion

I conclude that the MSFT dividend is safe for 2014 and into 2015, primarily due to the high dividend coverage ratio and the continued acceptance of the Microsoft ecosystem. In fact, I would not be surprised to see dividend growth of 15% annually for the next two years. Dividend growth in 2017 and later is not guaranteed.

MSFT's strategy will require substantial investment in datacenters and other infrastructure to support devices and services, and will bring continued competition with Apple, Google, and other well-established and emerging competitors.

Microsoft made its fortune by forging deep ties with companies such as Hewlett-Packard (NYSE:HPQ) and Dell, which make devices that run its Windows software, and Intel (NASDAQ:INTC), which makes the chips that drive those devices. This time around, it's proven willing to burn bridges to deliver an uncluttered message to consumers.

Disclaimer: The above article is an opinion, and not investment counsel.

Disclosure: The author is long DIS. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Microsoft's Dividend Coverage Ratio