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.
*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|
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.
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|
*Dividend increase already announced
Using these parameters, I arrive at a fair value estimate of $40 for a share of Microsoft.
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.