Microsoft (MSFT) has spent tens of billions of dollars on diversifying its product portfolio, which has given birth to a graveyard of failed products and segments. The company's most recent failure was Bing, a failed attempt to enter the search engine market. In fact, aside from its Xbox products, Microsoft has hardly had any success in its recently-launched products. We believe that the Surface tablet and the WP8 are about to change all that. The company has historically been very generous with shareholders, and has returned almost 57% of MSFT's current market cap in buybacks and dividends. We believe Microsoft is an excellent opportunity for investors looking for a high dividend yield and bonus growth prospects. Therefore, we are giving a buy recommendation for Microsoft.
Dividend and Buybacks
MSFT's dividend yield is much higher as compared to the industry average. The software giant pays an annual dividend of 2.93%, which is 37% more than the industry average.
Source: Reuters industry benchmarks
The most important ratio here is the growth in dividend. The company has a dividend growth rate of 14.7%, as compared to the industry average of 0.2%. This combined with a near industry payout ratio shows that MSFT is shareholder-friendly when it comes to dividends. Last week the company announced, for the seventh time since it started paying dividends, that it will increase dividends by 15%. The company was paying a dividend of 20 cents per quarter. This 15% increase will make the quarterly dividend 23 cents. The dividend was increased by as much as 20% on previous occasions.
click to enlarge images
If we look at the graph given above, we can see a steady increase in dividend yield. The continuous increase in dividend paid is even more prominent. This shows the company's inclination to increase distribution to shareholders, making it a valuable dog.
This high dividend yield makes the company very valuable, especially when combined with its huge share buy backs. In 2008, the company announced a mammoth $40 billion share buyback program, ending in September 2013. With a mix of dividends and share buybacks, the company has returned more than $150 billion to shareholders in the last decade. This makes up an impressive 57% of its current market cap.
If we look at the effectiveness of the two strategies, dividends are more useful to stockholders, while buybacks are more convenient for companies. MSFT is currently trading at forward P/E of 9.5x, which is way below the industry average of 28x and Nasdaq100's P/E of 16x. When trading at such low multiples, buybacks can be an effective strategy to support the stock price. However, if we look at the stock price movement for the last five years, the strategy seems ineffective. One can also argue that if not supported by buybacks, the price would have slumped much faster.
MSFT's primary concern for half a decade has been to find the next growth vehicle. This is why it has the second highest R&D, as a percentage of revenue ratio, amongst its peers. Combine this high growth with a number of failed projects and acquisitions and we get a very bad picture. We believe that MSFT has finally found its growth vehicle in the WP8 and Windows 8. Microsoft has already lost the PC war against smartphones and tablets. PC growth is slowing down, as the market reaches maturity. On the other hand, Google (GOOG) and Apple (AAPL) are dominating the mobile operating system landscape, but there is trouble in paradise; the world's largest smartphone OS, Android, faces imminent threat of litigation from Apple. Take into account Apple's recent legal victory over Samsung, a lot of uncertainty comes into play. Smartphone manufacturers and a significant number of users are looking for an alternative mobile operating system. The initial reviews of the Nokia (NOK) Lumia 920, which runs WP8, are very positive. Considering that Android is in trouble and Apple's iOS is limited to Apple products, we believe the WP8 can breakout as the next big thing in the smartphone industry. Microsoft has a history of high quality software products, combined with its strong relationship with OEMs, which could be the beginning of the next Microsoft ecosystem.
With a combination of buybacks and dividends, Microsoft has already distributed more than $150 billion to shareholders. Its low forward P/E, solid dividend yield, and growth prospects make us bullish on MSFT. Therefore, we reiterate our buy recommendation on MSFT for long-term investors.
Disclosure: The article has been written by Qineqt's Technology Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.