Seeking Alpha

Microsoft (MSFT) only began paying a regular quarterly dividend at the end of fiscal 2004, but the dividend growth has been fast and extremely well supported by cash flow. Currently trading at \$31.14 a share with a projected yield of 2.57%, Microsoft certainly does not have the highest yield. But the growth of the dividend is what matters, and heading into the future Microsoft should be able to support a much higher dividend. Here's a look at Microsoft's dividend history.

Year Dividend Growth
2005 \$0.32 N/A
2006 \$0.35 18.18%
2007 \$0.40 14.29%
2008 \$0.44 10.00%
2009 \$0.52 18.18%
2010 \$0.52 0.00%
2011 \$0.64 23.08%
2012* \$0.80 25.00%

*Announced dividend increase

With the exception of 2010, Microsoft's dividend has been growing at an extremely quick pace. Microsoft announced a 25% increase in fiscal 2012, and in addition is aggressively buying back shares. I'll calculate the payout ratio as a fraction of free cash flow. The results are shown below.

Year Free Cash Flow (Mil \$) Float (Mil Shares) Payout Ratio
2005 \$15,793 10,906 30.38%
2006 \$12,826 10,531 42.70%
2007 \$15,532 9,886 25.46%
2008 \$18,430 9,470 22.61%
2009 \$15,918 8,996 29.39%
2010 \$22,096 8,927 21.01%
2011 \$24,639 8,593 22.32%

The payout ratio in 2011 was 22.32%, which is extremely low. The cash flow should be able to support significant dividend increases in the future.

Valuation

I will use the dividend discount model to put an estimated value on the company. This model assumes that the value of a company is purely the sum of all future dividends discounted back today. This is a reasonable valuation method if you are a dividend investor. The discount rate should be your required rate of return, and I will use a discount rate of 8%, which is roughly the long-term growth rate of the market as a whole. I will assume that the dividend will grow by 15% next year, and then let that growth rate decay over 20 years to a perpetual growth rate of 3%, as per the growth table below.

Year Dividend Growth Rate
2012 25%*
2013 15%
2014 14.4%
2015 13.8%
2016 13.2%
2017 12.6%
2018 12%
2019 11.4%
2020 10.8%
2021 10.2%
2022 9.6%
2023 9%
2024 8.4%
2025 7.8%
2026 7.2%
2027 6.6%
2028 6%
2029 5.4%
2030 4.8%
2031 4.2%
2032 3.6%