As a retired technology company CFO and shareholder in Microsoft Corp. (MSFT), I found myself thinking about the outcry of criticism recently heard when MSFT "only" increased its dividend by 23% apparently disappointing a vocal analyst/investor base. I can't remember how many times I listened to someone on CNBC claiming the company wasn't managing its capital structure effectively. Rants of '"fire Ballmer" were pretty common and surprisingly loud given the general consensus about the quality of Windows 7, finally putting the fiasco otherwise known as Vista behind them. Granted, the missteps have been numerous over the past year from the Yahoo discussions through the recent life of Kin better measured in hours. But still, this is a company that grew its net income by $4.3B or 29% in the past year. Operating cash flow grew even more by $5B. They may have been steady a few years but did finally increase the dividend substantially and the share buybacks have totaled around $27B in the past 3 years. They even tried a special dividend based upon the outcry from investors wanting them to better utilize their cash. What's a company to do?
To satisfy a little personal curiosity I thought it might be interesting to compare them to a nontechnology company that is clearly seen as a yield-based investment vehicle. McDonald's (MCD) seemed to fit the bill. Here's a table of some data points worth referencing
|Proj'd secular growth||10.18%||10.37%|
|FWD PE multiple||16.4x||9.3x|
|Fwd PEG ratio||1.6x||0.9x|
|Next quarterly dividend||$0.61||$0.16|
|Forward dividend yield||3.2%||2.6%|
|June-10 net income||$1.226B||$4.518B|
|June-10 operating cash flow||$1.249B||$5.604B|
|Dividend/EPS payout pct||49%||29%|
|Dividend/Op CF payout pct||49%||25%|
So what does this tell us? Microsoft and McDonald's are targeted to grow at about the same rate in the next 5 yrs per analysts covering the companies. They are both buying back shares aggressively. MCD similar to many blue chip yield investments have a price earnings growth (PEG) multiple at 1.6x. MSFT on the other hand is viewed as an accidental yield company so they are primarily ignored by yield investors and are out of favor as a growth or technology company. Consequently, they are priced at a cut-rate PEG multiple of .9x. Makes some sense as they don't have a history of embracing dividends, growing them consistently and marketing themselves to yield based investment houses. But why not? They clearly are done as a growth-based company. 10% a year isn't too bad given their bulk and with the accretive share buybacks they should be able to achieve this even with the slow down of Windows 7 upgrade business going forward.
Looking even further into this valuation comparison, let's look at what I look at when determining the safety and potential for growth of the forward dividend stream-the payout ratio. The dividend percentage as a percentage of operating cash flow for MCD is 49% also viewed as 2x1 coverage. I view this coverage as pretty solid and one that many blue chip high yield companies try to maintain. It provides plenty of additional cash to fund growth and share buybacks while increasing the warchest for contingencies. So for simplistic purposes I'd say that they could be expected to increase their dividend payout at a rate that is similar to their organic growth.
MSFT on the other hand is only paying out 25% of is operating cash flow. If they were to increase their payout to a level that is similar to MCD to achieve a 2x1 coverage it argues that they have the operating capacity for a dividend of 5.2% or double the current rate. Now I know that yield investors care less about capacity than they do about the annual cash yield received, but it is another way of saying that on a discounted future cash flow basis, MSFT has the edge. I find it quite amazing that the management team at Microsoft would resist positioning themselves aggressively going forward to capitalize on their biggest attribute....cash flows. They are currently valued at around a 44% discount to MCD based on PEG rate when based upon free cash flow and dividend capacity they should be at a premium.
Why the resistance? Beats me. Could be ego or maybe it's a belief they would be less relevant as a technology innovator. I'm not complaining about the current increase or screaming for executive turnover. Just accept your new reality and embrace it going forward. Become a real innovator once again by becoming the first true blue chip technology yield company. My bet is your share price breaks out of this decade long holding pattern. I'd also bet that you will ultimately again change the technology landscape with others following your lead like they have done many times in the past.
Disclosure: Long msft, mcd