How Much Should Microsoft Raise Its Dividend?

| About: Microsoft Corporation (MSFT)

There has been a lot of recent debate over what Microsoft (NASDAQ:MSFT) should do with its dividend, which is usually increased around this time of year. The prevailing thought is that Microsoft will increase it between 2 and 4 cents a share from the current dividend of 16 cents. Analysts at both FBR and Goldman Sachs agree on this range. However, there was one analyst out there looking for a much bigger increase. In his August 30th note, Ticonderoga Securities analyst Neil Herman says that Microsoft should increase it to 6%, to match the payout ratios of its peers. So what should Microsoft do?

Let's take a look at Microsoft's dividend versus some other large tech companies. Apple (NASDAQ:AAPL), Dell (NASDAQ:DELL), Yahoo (YHOO), and Google (NASDAQ:GOOG) do not pay any dividends. As you can see from the chart below, Microsoft's dividend growth rate is at the lower end of the range over the past two years (chart represents annual dividend amount), but that is mostly due to the fact that 4 of the 5 (excluding Cisco (NASDAQ:CSCO)) have already increased their dividends this year. Microsoft's current yield is 2nd largest, so any raise from Microsoft will push the yield even further above most of its competitors.

Company 9/10/2009 9/10/2011 Increase Current Yield
Microsoft (MSFT)
$0.52 $0.64 23.08% 2.49%
IBM $2.20 $3.00 36.36% 1.86%
$0.32 $0.48 50.00% 2.12%
Cisco (CSCO)
N/A $0.24 N/A 1.52%
$0.56 $0.84 50.00% 4.26%
Oracle (NYSE:ORCL)
$0.20 $0.24 20.00% 0.92%

Now let's look at it from a cash flow point of view. Over the past 3 quarters, Microsoft has averaged $1.354 billion in paid dividends. That's about $5.4 billion a year in dividends at the current rate of $0.16. In the past fiscal year, Microsoft's cash flow was $4.105 billion. The company also repurchased over $11.5 billion worth of stock. So 1/3 dividends and 2/3 buyback, that seems fine to me. At the end of the most recent quarter, the company had approximately $9.6 billion of cash on its balance sheet.

So we all agree that Microsoft should raise its dividend, and that it has the cash on hand and cash flow needed to do so. But raising the dividend to a 6% yield would mean raising its actual payout to $13 billion a year from $5.4 billion. I think that's too much. I like the raise to $0.18 myself, along with an extension of the company's repurchase program. The FBR article says that Microsoft has about $12 billion left on its current buyback, and Goldman seems to believe a buyback extension is likely.

So why do I like the $0.18 number? Assume for the minute we raise it to that, and Microsoft's outstanding share number stays exactly the same going forward. That would be an increase of $158 million in payouts per quarter, or $631 million per year. With that increase, even if the rest of the company's cash flows balanced out to no change, it would take 15 years for the company to run out of cash. And this is a company that is generating positive cash flow.

So why not raise it more? I just prefer buybacks. Once those dividends go out, the company is not going to see that money again. At least buybacks will eventually improve the EPS number. And the more shares the company repurchases, the less total dollars it will pay out in dividends, giving it more room to either increase the dividend which I'm not a big fan of, or buy back even more shares. In the end, a raise to $0.18 seems fine to me. That's still a 12.5% increase, and a current yield of 2.8% based on Friday's close. I'd be fine with an increase to to $0.20, but let's not go too crazy here in these uncertain economic times. You can always increase it more next year if things turn out to be better than most expect.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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