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Why Microsoft Could Be the Next Great Dividend Aristocrat

By Bob Ciura

The Dividend Aristocrats are a select group of companies that have increased their dividends for 25 years or more.

The list is a great starting point for income investors who are looking for some of the best dividend stocks to invest in.

The reasoning is simple: dividend stocks with a track record of raising dividends for many years represent strong businesses with wide economic moats, capable management teams, and leading brands in their industries.

While Microsoft (MSFT) is not yet a Dividend Aristocrat, having raised its dividend for 14 years, it is almost assured to become one.

Microsoft is currently 1 of 274 Dividend Achievers – stocks with 10+ years of consecutive dividend increases.

The company has delivered very high rates of dividend growth for many years, thanks to its highly profitable business model which generates huge amounts of free cash flow.

MSFT Dividends

The stock offers a market-beating 2.8% dividend yield. It offers income investors the best of both worlds—a high yield and high dividend growth.

As a result, Microsoft could be the next great Dividend Aristocrat.

Underlying Fundamental Strength

Microsoft has come a long way since the bursting of the 1999 tech bubble.

In those days, many high-flying technology companies, including Microsoft, were much more speculative than they are today. They were not nearly as consistently profitable as they are now.

But Microsoft took control of the software industry, through its highly popular suite of products including Microsoft Office and its Windows operating system. Nowadays, Microsoft is turning focus to the cloud.

Microsoft has demonstrated significant progress in breaking away from the personal computer market, which is in decline.

Instead, it has positioned itself into higher-growth areas like the cloud. Due to the success of cloud-based platforms like Office 365 and Azure, Microsoft’s commercial cloud revenue soared 96% in the fourth quarter of fiscal 2015. Microsoft’s growth in recent years has been impressive; revenue was up 7% in fiscal 2015. It produced $23 billion of free cash flow in fiscal 2015. Microsoft has proven to be a phenomenal cash flow generator over many years.

MSFT Free Cash Flow
Source:  YCharts

Microsoft’s successful performance continued into fiscal 2016. Adjusted revenue and earnings per share, excluding the effects of foreign exchange, rose 5% and 10%, respectively, in the fiscal third quarter.

Once again, the cloud products were the major driver. Office 365 posted 63% constant-currency revenue growth, while revenue from the Intelligent Cloud business rose 8% in constant currency. Azure revenue increased 120% in constant currency last quarter. Overall, its commercial cloud business has exceeded a $10 billion annualized revenue run rate.

It has also seen great results from its gaming business. Driven by the release of the Xbox One console, Xbox Live monthly active users increased 26% last quarter.

None other than Mr. Wonderful has picked up on Microsoft’s strength.  Microsoft is one of Kevin O’Leary’s top holdings in his quality dividend ETF (OUSA).

Expect Years of Continued Dividend Growth

Thanks to its excellent fundamental strength, Microsoft can return a great deal of cash to shareholders.

In fact, the company returned more than $24 billion to shareholders last fiscal year in combined dividends and share repurchases.

It has aggressively grown its dividend in recent years. Microsoft has raised its dividend by 17% compounded annually over the past five years. With such strong dividend growth, an investor can expect their dividends to double every four years.

Going forward, there is every reason to expect Microsoft’s high dividend growth rates to continue. The company’s dividend payout ratio as a percentage of free cash flow was 42%; the fact that the company is still distributing less than half of its free cash flow is a great sign for future dividend growth. Another great sign is that Microsoft holds a pristine balance sheet.

Microsoft is one of only two U.S. based companies to hold the coveted ‘AAA’ credit rating from Standard & Poor’s. The company has $116 billion in combined cash, short-term investments, and long-term marketable securities on its balance sheet. It has a 2.8 current ratio, implying excellent short-term liquidity. Long-term, debt is not a concern for shareholders. Microsoft maintains a healthy 54% long-term debt to equity ratio.

Final Thoughts on Microsoft & The Technology Sector

Thanks to Microsoft’s excellent growth rates in its newer cloud-based businesses, as well as continued success in Microsoft’s hardware and other businesses, it has more than enough financial flexibility to raise its dividend at high rates. There are simply very few stocks that can match Microsoft’s unique blend of a high current yield as well as high dividend growth.

The company is exhibiting an ability to adapt with changes in the technology industry.  IBM (IBM) is one of the only examples of a technology company that has been able to grow for very long periods of time (IBM was founded in 1911).

Microsoft could be another technology industry stalwart that is able to fight against rapid change in the industry and generate rising dividend income over time.  Microsoft’s wide diversification within the technology industry combined with its cash hoard and tremendous free cash flow creation make Microsoft one of the most likely companies in the technology sector to generate rising dividend income over time.

Whether you are a retiree looking for income now, or a dividend growth investor with a long time horizon, Microsoft makes a compelling investment if you are looking for an investment in the technology sector.

With that said, Microsoft (or any other technology firm) does not have the same level of long-term safety as the best businesses in the consumer staples sector.  This is because the technology industry changes so much faster.  We will always eat food and drink beverages.  Thirty years from now, who can really say what the future of the technology industry will be.

A long-term investment in Microsoft is an investment in the belief the company will be able to adapt to the ever-changing technology landscape.  Microsoft’s excellent balance sheet, huge amounts of free cash flow, and diversification make the company one of the best dividend investments in the technology industry.

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