If you're looking to buy a partial ownership stake in
a publicly-traded company, then there are a number of things that
you should consider before doing so. These things include the
company's business model, historical earnings growth and corporate
governance. Another thing that you may want to consider is the
Dividends are very important as they can provide
some cushion for investors to the downside and can also signal
confidence from management in the company's future. Many investors
pursue dividend-paying stocks to augment their returns with a nice
income stream. Most of them prefer to diversify into many different
sectors of the economy in order to spread out their risk.
Today, let's take a look at Microsoft,
a huge player
in the technology sector of the economy. Let's see how the dividend
of Microsoft stacks up in terms of strength and
sustainability and what investors can expect going forward.
The first and most obvious consideration when
evaluating a company's dividend is the dividend yield, which
represents the percentage of your investment that you'll receive
back over the next 12 months at current share prices and dividend
yields 2.8%. This is a forward yield that is based on the most
recent dividend payout of 28 cents per share. Its current yield is
near its five-year high of 3.1%. Over the last five years, the
dividend yield of Microsoft has ranged between 1.7% and 3.1%.
When analyzing a dividend, it's not all about the
yield. As an income investor, you want that dividend to grow over
time in order to protect your income stream from the erosive effects
of inflation as well as to show confidence from management in the
Microsoft has increased its dividend in each of the
last four years, at an average annual rate of 21%. This comes after
they held the dividend steady between 2009 and 2010. This company
has paid a dividend each year, going back to 2004. While it is true
that dividend growth on the order of 20% or more probably won't go
on forever, Microsoft is trouncing inflation at this point in time.
Free Cash Flow Payout Ratio
While high dividend yields and strong dividend growth
are nice, we need to make sure that the company in question can
generate enough cash flow to cover its dividend payment. The free
cash flow payout ratio tells us what percentage of the company's
free cash flow is eaten up by dividend payments. Lower free cash
flow payout ratios are better as they leave more room available for
future dividend increases or other uses of the capital.
Free cash flow is the cash flow a company generates
in its operations minus capital expenditures.
Microsoft paid out just 36% of its free cash flow
over the last 12 months in dividends. This payout ratio should rise
modestly, given that Microsoft just increased its dividend last
fall. While the current free cash flow payout ratio of Microsoft is
higher than the 23.5% of free cash flow that was paid out on average
over the last four years, Microsoft's dividend is currently very
From looking at the company's free cash flow payout
ratio, it can be concluded that the dividend is in no danger at this
point in time.
Interest Coverage Ratio
One of the ways in which we can determine whether or
not a company will have trouble paying its dividend in the future is
by looking at how much interest it has to pay every year. More money
spent on interest means less money that is left for dividends. To
determine the effect that debt has on a company's ability to pay its
dividends and fund other activities, I calculate the interest
coverage ratio. This ratio is calculated by dividing the company's
earnings before interest and taxes by its interest payments over the
year. You generally like to see this ratio at or above 2. If it's
below this figure, then that may signal trouble ahead for the
company in question.
Fortunately, this is not a
problem at all for Microsoft, as the company had no net interest
expense over the last 12 months. This is because the interest
expense that they had was more than offset by interest and dividends
that the company received from its investments.
At this point, debt is
not having an effect at all on the company's ability to pay its dividends.
Earnings Per Share Growth Forecasts
While it's good to look at what
past dividend payouts have been and how they relate to past
earnings, we need to get an idea as to what future dividend payouts
are going to look like. One of the ways in which we do this is by
looking at analyst forecasts for earnings-per-share growth. This
year, analysts expect Microsoft to increase
its earnings per share by 2.2%, followed by an 8.2% increase in 2015.
Over the next five years, the company is expected to increase its
earnings at an average annual rate of 8.5%. It should be mentioned that these projections are
all based on non-GAAP
The current dividend of Microsoft is well-covered by
its free cash flow. With a low free cash flow payout ratio and mid
to high single-digit earnings per share growth on the horizon,
double-digit dividend increases from Microsoft should continue in
the near term, depending on how much the company wants to expand its