Is Microsoft A Good Dividend Stock?

Summary

• Microsoft stock yields only 0.9%.
• It is still an amazing dividend stock as the strong forward growth rates more than compensate for the low starting yield.
• The company is still growing at robust rates, powered by its cloud division.
• The company maintains a cash-rich balance sheet and has generously rewarded shareholders with dividends and share repurchases.
• I rate the stock a buy as a lower-risk option in the tech sector.
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Sean Gallup/Getty Images News

Microsoft (NASDAQ:MSFT) is the rare tech stock that can deliver robust growth while generating huge profit margins and rewarding shareholders. While the dividend yield might not look that enticing at less than 1%, the stock may nonetheless reward dividend investors through aggressive growth rates over the coming years. Further, with the stock trading at an earnings yield just over 3%, shareholders are also being rewarded through ample share repurchases. This is a case where it can pay off to pay up for quality.

MSFT Stock Price

Even amidst a crash in the broader tech sector, MSFT is still trading not far from all-time highs.

Data by YCharts

Now trading at just around $280 per share, the stock is still offering plenty of potential forward returns for long-term investors.

MSFT Stock Key Metrics

In the latest quarter, MSFT delivered typically strong growth, with overall revenue growing 18% (21% adjusted for constant currency) and operating income growing a bit faster at 19% (23% adjusted for constant currency). Net income grew slower at 8% because the prior year's quarter benefitted from a $620 million tax benefit. Earnings per share grew slightly faster due to ongoing share repurchases.

Microsoft FY22 Q3 Presentation

MSFT's core productivity and business processes segment delivered solid growth and continues to be a cash cow with 45.5% operating margins.

Microsoft FY22 Q3 Presentation

MSFT saw its weakest results in its gaming segment - largely due to tough pandemic comparables.

Microsoft FY22 Q3 Presentation

While the investors may typically know MSFT based on the above two segments, the cloud segment has quickly become the largest segment by revenue. Over time, I expect MSFT to be known primarily as a cloud company. Cloud revenues grew 26%, powered by 46% growth from Azure. Operating margins were also very strong at 43.5%.

Microsoft FY22 Q3 Presentation

The company generated $20 billion in free cash flow and returned $12.4 billion to shareholders through $7.8 billion in share repurchases and $4.6 billion in dividends. MSFT ended the quarter with $104.7 billion in cash versus $49.9 billion in debt for a $54.8 billion net cash position.

Is Microsoft's Dividend Yield Good?

At first glance, MSFT might not look like an attractive dividend stock due to the low 0.9% yield.

Seeking Alpha

Further, the dividend growth rate has hovered around 10% over the past 5 years - a solid rate, but not one that totally offsets the low yield.

Seeking Alpha

What's going on?

Is MSFT Stock's Dividend Safe?

The key here is that the past dividend growth rate is likely understated in comparison with forward growth rates. MSFT has been growing earnings per share at a 30% clip over the last 5 years. Dividend investors should focus on underlying earnings for a better understanding of true dividend safety because dividends are paid out of earnings. We can see that Seeking Alpha rates MSFT's dividend with a safety score of A+.

Seeking Alpha

That grade makes sense in light of the strong underlying earnings as well as the $54.8 billion net cash balance sheet position. While the low 26% dividend payout ratio is worth mentioning, that metric is less important than balance sheet strength and forward growth outlook of the business - both of which, as mentioned, are very bright for this company.

Is Microsoft A Good Long-Term Stock?

While MSFT is not an obviously cheap stock, the company is expected to sustain robust growth over the next decade.

Seeking Alpha

Those earnings growth projections look reasonable when compared against consensus revenue estimates.

Seeking Alpha

Consensus estimates call for the company to achieve 46.3% net margins by 2031. For reference, MSFT has achieved a 38.3% net margin through the first 9 months of its 2022 fiscal year. That 800 basis points of projected margin expansion looks very achievable considering the high scalability of MSFT's software products. MSFT hasn't shown materially greater operating income growth (relative to revenue growth) in this past quarter, but that is likely due to aggressive investment in growth, as evidenced by the 21% growth in R&D spending. I expect MSFT to soon start showing large levels of operating leverage as top-line growth begins to flow directly to the bottom line.

Is MSFT Stock A Buy, Sell, or Hold?

While there are cheaper alternatives in the tech sector, MSFT remains a buyable stock. It is currently trading at 8.9x 2031 consensus estimates. Due to the strong balance sheet, persistent growth, and high levels of shareholder returns, I could see the stock trading at a 2.5x price to earnings growth ratio ('PEG ratio'). That would place the stock at 25x earnings, or a price of $791 per share by 2031. That represents potential returns of over 11% annualized from capital appreciation alone. Throw in the roughly 1% dividend yield, and that edges up higher to around 12%. I note that MSFT may be able to beat consensus EPS estimates due to ongoing share repurchases. I expect a 12% annualized return to beat the overall market from here though potentially fall short of keeping up with more beaten down tech names. There are two key risks to consider here. First, the projected returns are highly predicated on both the company's ability to sustain solid growth rates and a premium multiple. Due to the company's growing investment in R&D, annual double-digit growth looks reasonable from here - not to mention that the company may be able to accelerate EPS growth by taking more leverage later. It is possible that MSFT trades at a lower earnings multiple as growth slows, but I still expect it to sustain a premium multiple in light of the high free cash flow generation and willingness to return capital to shareholders through dividends and share repurchases. The other risk is that of regulatory intervention - MSFT has been able to sustain premium multiples relative to the likes of Alphabet (GOOGL) and Meta Platforms (FB) largely due to investor perception that MSFT is not as targeted by regulators. Should that change, which shouldn't be ruled out considering the company's size, the premium multiple may also go away. I rate MSFT a buy in light of its robust fundamentals, though note the high likelihood of better opportunities elsewhere in the tech sector.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of FB, GOOGL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I am long all holdings of the Best of Breed portfolio

Comments

[kata]

Thats an ugly chart for a company actually growing revenue faster.

[Stomp!]

Buy your position in MSFT and keep it for 10 years
it's better then money at the bank.

[Josh.Gotcha]

MSFT dividend seems trivial, in contrast to many other names. It might be a factor for some, but I believe the majority of MSFT investors are buying into its high growth prospect.

[Willow Street Investments]

@Josh.Gotcha I bought MSFT in 1996...I get $8,000 a year I dividends and am in it for the dividends at this point. Looking forward to 10% increases into the future.

[Josh.Gotcha]

@Willow Street Investments I see. Well, in that case, you'd be way better off if you swtiched to ATT instead. But would you do it?

[Willow Street Investments]

@Josh.Gotcha Would not be better off with T.

[Advanced_Tech]

Microsoft is a growth stock not a dividned stock.
if you want to buy a stock for the income and dividends
you should buy something with a much higher yield.
Canadian Banks are a good example
for a great dividend stock.

[Steve Rasher]

@Julian Lin Thanks for the article. Let's face it one of the main reasons the yield is relatively low is that the stock appreciation over the last few years has far outpaced the healthy growth of the dividend. I bought a number of years ago and have a basis under $30, and at that time the yield was attractive at around 3%. Although the current dividend is 3 times that of when I bought, the current yield is 1/3 of the yield when I bought. So yes, one can buy for dividend growth as well as over all growth and stock appreciation. Steve

[Julian Lin]

@Steve Rasher Yes, absolutely. If one is willing to sell a little then the overall yield will be quite generous.

[Steve Rasher]

@Julian Lin Actually, although I rarely sell because of valuation when the investment thesis is still intact, I did trim 20% of my position at $329 because I had some compelling opportunities to redeploy the proceeds in stocks that would significantly increase my dividend cash flow and leave some cash as well. Yes, my timing was pretty good in hindsight, but I consider it more luck and intuition rather than some deep analytical skills. Steve

[stevewin]

You have to be kidding me. No one buys msft for div growth. Get a new job

[Chalmus0]

@stevewin Whoa, someone who knows every investor, and what their motivation is for buying every stock!

Sadly, you must have forgotten to interview me before writing your comment, because dividend growth is a requirement on a stock before I consider it for purchase. Therefore, because MSFT has dividend growth, it passed my screens and I bought it. Wasn't the sole reason for sure, but I would not have bought it if it failed that screen.

[TaiPan]

@Chalmus0

Great answer. But you forgot to include a brief mention of the value of civility, for the benefit of @stevewin.

[4%]

@stevewin I actually buy this for the dividend. But I also appreciate the sector and even though 1% sucks in dgi. It still goes up 10% ish a year.

[Kenyatta]

There is no doubt that MSFT is a great stock. But it is paying a very tiny amount as a dividend. For me living on dividend income and needing at least 6-7% , it is not appealing. While dividend happens clockwise, capital appreciation is unpredictable. So there is potential that one will have to sell the stock at an inopportune time to fund monthly living cost. A company paying a small dividend may indicate lack of confidence in itself.

[Julian Lin]

@Kenyatta You state that capital appreciation is unpredictable, but is it really? Food for thought: many investors like to live entirely off dividends. I view this to be very risky in the current environment given the low yields. Yet if one were to instead just go 100% in the S&P 500 and sell 4% of the starting amount (note that detail) every year, then they'd arguably have a consistently growing amount of money.

The key point to understand is that even in a 50% decline, you aren't selling everything.

[ChuckXX]

I think this is the first time I've ever seen anyone come out with EPS estimates out to 2031. I think we all know that is a moonshot towards a dart board. Thank You for the nice article though.

[Julian Lin]

@ChuckXX It's all about trying to see what kind of returns to expect using reasonable assumptions.

[rgj]

.9 dividend is nothing when inflation is at 12 to 14%

[Julian Lin]

@rgj There's more to stocks than just the dividend...

[rgj]

@Julian Lin Not when they’re going down

[MLian]

MSFT is a strong growth stock but not a good dividend paying company.

[Julian Lin]

@MLian Say more?

[Chalmus0]

@MLian After owning them for 6.5 years or so, I'm getting around 5% of my initial investment back per year, and I expect that to continue growing at a very nice clip for a very long time.

It's one of those dividend stocks that adds a lot of growth to your portfolio, and should pay out a decent amount after some time as well. To me, I put it in a similar category as V, MA, AMT, BAM, etc. -- good overall growth, also happen to have very good dividend growth, I've been long those names for 5-7 years already, and have another 15 years until retirement, so by that time I should be getting a pretty healthy chunk of money from them too.

[MLian]

@Chalmus0 As of today, MSFT dividend is pity. Better of course than FB or Google or AMZN who pays no dividends at all. FYI, I own MSFT since $25.

[Matthew Brown]

Good article.

One nit pick: "Dividend investors should focus on underlying earnings for a better understanding of true dividend safety because dividends are paid out of earnings."

Dividends are not paid from earnings, which include all sorts of non-cash metrics. They are paid from cashflow.

[Julian Lin]

@Matthew Brown We're arguing semantics. I of course am referring to true "owner earnings," and not accounting-inflated earnings. The "intuitive" definition of earnings, you could say.

[TaiPan]

@Julian Lin @Matthew Brown

Semantics are words, and clarity is important. If you (Julian) have to explain what you meant by “earnings”, (e.g. not from earnings per se but from effective ‘shareholder earnings’ -- which sounds like modified cash flow), then it may be time to consider using different terminology.

[Julian Lin]

@TaiPan Fair, but in this case it's reasonable to assume by "earnings" one means the intuitive sense of the word, and not "GAAP earnings with a ton of non-cash accounting adjustments."

[Chalmus0]

Bought them in 2016, and plan to hold them for....well, ideally forever. I've been working in IT for coming up on 3 decades now, and Microsoft has never been in a more dominant position IMO. That, and they were one of the first ones to go through the antitrust wringer, so they hardly ever get brought up in the conversations about "big bad tech companies that we need to do something about"

Long, staying long, and would say that anyone with a reasonably long timeframe could hardly ever go wrong by adding MSFT.

[Julian Lin]

@Chalmus0 Thank you for sharing