Microsoft Corporation (MSFT) continues to reward shareholders with a recent 11% raise in the quarterly dividend to $0.51 per share from $0.46 per share. The dividend increase is the 15thconsecutive increase since 2004 making the company a Dividend Contender. The forward yield is 1.47%, not much to write home about. But still, the dividend is extremely safe. The current payout ratio is 38.8% based on a forward dividend of $2.04 and consensus 2019 EPS of $5.26 per share. This is a very conservative value and well below my threshold of 65%. From a free cash flow or FCF perspective, the dividend coverage is solid. Microsoft generated over $38B in FCF in fiscal year 2019. The dividend required $13.81B giving a dividend-to-FCF ratio of 36%, which is well below my threshold of 70%. In context of debt, the dividend is rock solid. Microsoft is one of only two companies with a AAA-rated balance sheet. The other being Johnson & Johnson (JNJ). Total debt was about $78.37B at end of Q4 FY 2019, which sounds like a lot. But Microsoft had over $133B in cash, cash equivalents, and short-term investments on hand at end of Q4 FY2019 more than offsetting the total debt. The debt-to-equity ratio is 0.77 well-below my threshold of 2.0. In addition, interest coverage is over 17X meaning that the company can meet its obligations.
Microsoft also announced a $40B share repurchase, a fairly large amount. But still, this is only about 4% of the Microsoft’s $1T market capitalization and the stock is trading near its all-time high. So, spending $40B to buy back stock at this time might not make sense.
With that said, Microsoft is clearly a stock that I like to own. The stock has generated excellent trailing 10-year average annual returns of about 21.4% with dividends reinvested and 19.5% without dividends reinvested. Both of these metrics trounce the S&P 500’s trailing 10-year average annual returns by a wide margin.
But due to these trailing returns one has to pay a premium for Microsoft since the stock is trading at a forward P/E ratio of 26.3 based on consensus 2019 EPS. This premium is unlikely to come down much in the near future due to Microsoft’s current and expected growth rate. The company is a major player in cloud architecture and is firing on all cylinders. This has driven growth across the company. Microsoft’s cloud businesses are growing at a high double-digit rate for the past few years and this looks to extend for the foreseeable future. Microsoft’s Azure product is a viable alternative to Amazon’s AWS and has recently been growing faster. Even Office 365 is generating solid growth after the company switched to a software-as-a-service (SaaS) business model. Additionally, Microsoft has a dominant or major presence in video games with Xbox, servers, operating systems with Windows, SQL Database Management System, developer tools with GitHub and Visual Studio, and even social media with LinkedIn. Microsoft even has a presence in hardware with the Surface tablet but is not the market leader. One concern is that Surface has no competitive advantage representing one of the few weaknesses in the company’s product line.
From a valuation perspective, I view Microsoft as fairly valued and one should probably wait for a better entry point. With that said, the stock’s beta is about 1.10 so in market downturns it should decline greater than the market averages. In fact, in early 2019 the stock dropped as low as ~$94. This was a good entry point and the stock rapidly recovered after that 52-week low. Hence, I will track Microsoft and wait for another downturn before adding to my position.