When it comes to dividend investing, tech stalwart Microsoft (NASDAQ: MSFT ) has surprisingly landed on many income investor's radars. The first reason is industry specific: Until recently, technology was one of the last places investors looked for returned capital -- instead, tech was considered a growth industry. The second had to do with the company itself. Outside of its Windows operating system and Office products, the company hasn't executed well with new products and services.
However, the company appears to be in the midst of a turnaround by its 40% return over the last year. Investors have been receptive to Microsoft's plans to transform from a software company to what former CEO Steve Ballmer described as a "devices and services" company. Even after that tremendous run, the company pays a dividend that yields nearly 2.4% -- nearly the yield of the 10-year Treasury.
So, you can see how income investors have placed Microsoft in their sites. Here are two things dividend investors need to know about Microsoft.
The company could easily pay the dividend from its cash pile... if that pile was in the U.S.
When looking at dividend-paying investments, sustainability is key. Yield is great, but more important is if the company can continue to pay its dividend. If not, dividend cuts can occur, generally leading to tumbling share prices as well. Generally, there are two sources of cash for dividends: a company's current cash on its books, and cash from operations.
As far as cash in the bank, Microsoft appears solid. As of its last fiscal quarter, the company had an astonishing $85 billion of cash and short-term investments in the bank. They paid nearly $9 billion in common dividends last fiscal year, so the company could theoretically pay dividends from its cash pile for nearly 9.5 years without cash from operations.
However, there's a wrinkle for Microsoft. The company must pay dividends from its domestic cash pile, or bring cash back from abroad and pay the full corporate tax rate of 35%. The company doesn't disclose what percentage of its cash it stores abroad, but UBS analyst Brent Thill pegs the number at a mere $9 billion -- only a single year of dividends. The company doesn't feel it is a problem, however:
We expect existing domestic cash, cash equivalents, short-term investments, and cash flows from operations to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities, such as regular quarterly dividends, debt repayment schedules, and material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future.
The dividend isn't the most impressive part of Microsoft's capital return program
Microsoft has also been returning money to shareholders by its capital return program in addition to its dividend. By buying back large blocks of stock, the company enriches current shareholders, because each investor has a larger claim on earnings.
Over the last five fiscal years, Microsoft has returned back a total of $73 billion to shareholders. The largest part of that cash is actually its repurchase program that comes in at over $40 billion, common dividends are nearly $32.5 billion during that time frame. The share repurchase program has lowered Microsoft's shares outstanding from over 8.9 billion to its 2014 total of 8.4 billion -- a total share reduction of nearly 6%.
Although income investors clamor for dividend growth -- and Microsoft has provided that by increasing total dividend payout from $4.6 billion in 2010 to nearly $8.9 billion last year -- it's better when the company is also increasing earnings per share. By reducing the share count, Microsoft can grow earnings per share without actually increasing its bottom line, and if the company does increase net income, investors are entitled to a larger part of those profits.
At first glance, income investors might look past Microsoft as a suitable investment -- and that's unfortunate. Because of the dominance of its Windows product and its impressive repurchase program, the company is intently focused on returning cash to shareholders. Of course, wise dividend investors would prefer more of its cash to be domestic rather than foreign, but the company could repatriate if necessary -- although it doesn't feel it needs to at this time.
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