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% |
*Dividend increase already announced
Using these parameters, I arrive at a fair value estimate of $40 for a share of Microsoft.
Conclusion
Microsoft's dividend has been growing at a fast rate since it's inception and is supported by an extremely low payout ratio. This should allow the dividend to grow substantially in the future. At current prices, Microsoft offers a bargain for a dividend-focused investor, trading at a substantial discount to my fair value estimate. Although Microsoft doesn't have nearly as long a history of raising dividends as other companies, it offers a compelling value for a dividend investor.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
