On September 18, Microsoft (MSFT) announced its latest dividend increase. Microsoft is set to pay a 23-cent dividend on December 13, for shareholders of record on November 15. Microsoft's new payout is a 15-percent increase above the prior quarter, when the company paid out a 20-cent per share dividend. These moves come in the aftermath of dividend increases from Silicon Valley titans Cisco (CSCO) and Intel (INTC). The favoritism towards income payouts instead of retained earnings is a sign of the times. Following the late 90s-Y2K boom, the personal computer and its underlying Web 1.0 infrastructure are now commodities.
Microsoft offers a 2.95% dividend yield. This performance is actually competitive, considering the fact that financial markets are dealing with accommodative monetary policy that is to last indefinitely. Adjusted for inflation, real returns on fixed income investments are now less than zero. Microsoft is a beta stock that will track the S&P 500 Index and make regular dividend payments. For the sake of comparison, the Apple Corporation (AAPL) is an alpha investment that consistently outperforms the major indices. As an alpha business, Apple's iPod, iTunes, iPad, and iPhone ecosystem sets the financial standard. Behind Windows 8, Microsoft is now a conservative beta follower attempting to copy success of the Apple Way. In Wall Street parlance, however, the easy money has already been made.
Ironically, Charlie Sheen may describe conservative income investing as "winning." Despite the looming Windows 8 release, Microsoft shareholders in the market for a long-term outperformance will be disappointed.
The Federal Reserve Board
Earlier this month, Ben Bernanke and the Federal Reserve Board detailed plans for a third round of quantitative easing. This latest stimulus package calls for The Federal Reserve to purchase $40 billion in mortgage-backed securities every month. Taken together with Operation Twist, Annalyn Censky and CNN Money report that QE3 will add $85 billion in long-term bonds to the already bloated Federal Reserve Balance sheet each month. At present, The Fed commands a $2.8 trillion balance sheet, while the federal funds rate remains effectively zero. Paul Volcker, former Chairman of The Federal Reserve, describes QE3 as the "most extreme easing of monetary policy" that he has witnessed.
Accommodative Federal Reserve policy exacerbates financial risks for conservative investors holding Microsoft stock specifically for income. This QE3 program to increase the money supply will weaken the dollar and trigger silent inflation. During silent inflation, headline indicators, such as the Bureau of Labor Statistics Consumer Price Index (CPI) appear benign. CPI calculations largely take into account U.S. wages, which trend downwards amid underemployment and globalization. Alternatively, hyperinflationary tuition and commodity prices are likely to destroy the middle-income budget beyond its breaking point. Microsoft's 2.95% dividend yield is of little consolation for a professional Charlotte family that must contend with 7% annual tuition increases at The University of North Carolina.
Today's accommodative monetary policy is in response to the 2008 financial crisis. Despite the headlines, quantitative easing programs have yet to create jobs, as evidenced by a stubborn U.S. unemployment rate that remains above 8-percent. If anything, QE3 will keep fixed income investment rates at zero, and encourage capital flows into commodities and stocks. Microsoft offers stable value for shareholders if it combines its traditional software business model with regular dividend increases.
Microsoft Windows 8 Specifications
On October 26, Microsoft is set to launch Windows 8 in conjunction with its Surface tablet. Microsoft's new software platform is a fusion of conventional personal computer, tablet, and smartphone interfaces. For example, Windows 8 users can enter desktop commands through touch screen technology, before picking up a Microsoft Surface tablet and toggling through tiles that open up Excel calculations. According to Dan Costa and PC Magazine, this hybrid model of separate hardware platforms beneath one Windows 8 umbrella is a "huge gamble" for Microsoft.
Microsoft Windows 8 is the answer to Apple's integrated ecosystem that includes the iPod, iMac, iPhone, and iPad. Microsoft executives are hopeful that Microsoft Surface tablet and Windows 8 phone profit can counter anemic PC software licensing sales growth. For Apple's latest fiscal third quarterly period ended June 30, this company reports 26 million and 17 million in iPhone and iPad sales, respectively. Taken together the iPhone and iPad combined for $25 billion of Apple's Q3 2012 $35 billion total net sales. Year-over-year iPad sales are growing at an 84-percent clip. Meanwhile, research firm comScore reports that the Apple iOS and Google Android duopoly control 85% of the smartphone market. In this environment, only a truly revolutionary Windows 8 release would sustain growth for a $260 billion corporate behemoth.
The Microsoft Surface is a bold move to bridge the gap separating tablets and notebook computers. Microsoft promotes the sleek profile of its new tablet that weighs in at 903 grams and measures 13.5 millimeters in thickness. For portability, this Surface tablet keyboard and kickstand can be folded together as a literal silicon billfold. Stereo speakers, Skype teleconferencing, and a 22-degree rear-facing camera shape the audio-visual experience. Lastly, a USB port for printing, file sharing, and phone charging enhance hardware versatility.
Following Microsoft Surface, the Samsung (SSNLF.PK) ATIV S and Nokia (NOK) Lumia 920 Windows 8 handsets are set for launch amid the Holiday Season. Nokia markets its 920 as a phone that is, "designed to wow," in five separate available colors. The Lumia 920 features a 4.5-inch screen and converts into a camera for taking pictures in 8.7-megapixel resolution. Alternatively, the Samsung ATIV S is notable for its brushed aluminum finish and lightweight feel. For data, the Samsung's flagship Windows 8 phone connects to the 3G Network. A 1.5 GHz Qualcomm Snapdragon S4 dual-core processor powers both the Samsung ATIV S and Nokia Lumia 920 handsets.
As a rebuke of Microsoft's marketing machine, Wall Street is not necessarily impressed with Windows 8. On September 5, Stephen Elop, CEO orchestrated his Lumia 920 prototype demonstration in New York City. That very same day, Nokia stock lost 15-percent in value. Meanwhile, Apple shares have advanced from $580 to $700 over the past month, alongside Peter Oppenheimer's foreshadowing of a blockbuster iPhone 5 launch.
The Bottom Line
In lockstep with the Lost Decade, Microsoft stock has done nothing since the 2000-2002 dot-com bust. Microsoft is effectively a utility that dominates a particular sector, to the point where real growth is mathematically improbable. For the past five years, Microsoft earnings have flat-lined near a $17 billion water level. Windows 8 is not likely to move the needle significantly at Microsoft, which would be best described as a beta stock value play. As such, Microsoft stock is effectively a leading economic indicator. In terms of capital appreciation, Microsoft stock is likely to stagnate alongside anemic gross domestic product growth expectations over the next two years.
During fiscal 2012, Microsoft generated a staggering $31.6 billion worth of cash flow from operations. Rather than reinvesting cash back into the business, Microsoft spent $6.4 billion on cash dividends, a net $3.1 billion on stock buybacks, and a net $12 billion on investment securities. Last year, Microsoft returned $11.4 billion of its $17 billion in net income to shareholders. Redmond has effectively conceded defeat and waved the white flag on the Microsoft growth story.
Prior to its most recent 23-cent quarterly dividend authorization, Microsoft doubled its payout from 10 to 20 cents per share, in the five years between fiscal Q4 2007 and Q1 2012. Microsoft slowed its annual dividend growth rate from the 25-percent rate between 2011 and 2012 to this latest 15% year-over-year increase into Q1 2013. If Microsoft adjusts policy to offer a 20% annual dividend increase, it would then pay 28 and 34 cents in quarterly dividends over the next two years. For 2015, this calculates out to a $1.36 per share annual dividend.
If Microsoft stock stalls out at $30, it would then offer a 4.5% dividend yield into 2015. As a sign of the times, desperate savers will happily accept risky promises for 4.5% equity returns, instead of the measly 0.90% rates offered on FDIC guaranteed two-year certificates of deposit.
Compared to other equities, however, Microsoft stock is a loser's bet in terms of risk versus reward metrics. Cisco and Intel technology stock charts demonstrate positive correlation to Microsoft. For buy-and-hold income investors, Cisco and Intel both exceed Microsoft's current payout. Cisco offers 3%, while Intel pays out a 4% dividend yield. Over the past five years, Cisco and Intel have both generated between $10 and $20 billion of stable annual operating cash flow. Last quarter, Cisco raised its quarterly dividend from eight cents to fourteen cents per share, for an aggressive 75-percent increase. In recession, however, cyclical technology stocks expose investors to capital losses and even dividend cuts.
Consumer staple stocks such as Altria (MO) and Coca-Cola (KO) are more suitable for equity investors mining for yield. Today, Altria and Coca Cola offer 5.1% and 2.7% in dividend yield, respectfully. Compared to technology, economists would highlight tobacco as an industry that exhibits inelastic price demand. In other words, conservative income investors may describe Altria stock as "recession proof." Altria shares have more than doubled from $15 to $34 between the start of 2009 and Q3 2012.
For the sake of growth and income diversification, Apple remains a more compelling story than Microsoft stock. Microsoft and Apple trade for fifteen and sixteen times earnings, respectively. While Microsoft earnings growth measures nil, Apple is averaging 66% average annual net income growth during the course of the past four years. For the latest fiscal third quarterly period ended June 30, 2012, Apple closed out its books with $117 billion in cash and investments on the balance sheet. At $690, each share of Apple stock carries $125 in cash and investments, or roughly $70 in net liquidity if Peter Oppenheimer, CFO, effectively wrote checks to pay off all corporate debt.
On September 21, Apple launched its iPhone 5. After a relatively disappointing first weekend of sales, I am projecting that Apple ships out 100 million iPhone 5 units for $65 billion in 2013 revenue. This performance will trickle down to $20 billion in bottom line profits for Apple. Largely behind torrid iPad sales growth, Apple will close out fiscal 2013 with $50 billion in net income. If Apple maintains a price multiple of fifteen times earnings, Wall Street would then value this corporation at $750 billion in market capitalization. For next year, this $750 billion market capitalization divided by 929 million shares of common stock outstanding calculates out to an $800 per share price target. As an income investment, Apple features a 1.5% dividend yield to boot.
In 1999, a hostile U.S. Department of Justice threatened to break up the Microsoft monopoly. Today, as a sign of the times, Microsoft is largely unworthy of investment capital.