Microsoft: Future dividend superstar?
Once known as the quintessential high-growth technology stock, Microsoft [[MSFT]] has in recent years become viewed more as a mature, conservative value play that happens to be in the technology sector. Adding to this transformation was the company’s decision in 2003 to begin paying dividends to shareholders.
Until fairly recently, however, the stock was yielding a fairly paltry ~1-2%. But a recent dividend hike along with a falling stock price due to the bear market and disappointing earnings have resulted in a recent yield as high as 3%. Could it be that MSFT is now both a value and dividend play?
Dividend growth to continue?
With only six years of dividend history – and only the last four showing a dividend increase (not including a $3/share special dividend in 2004) – MSFT has not yet earned even three-star status (i.e., five years of dividend increases) on DividendInvestor.com, much less the right to be included among such elite dividend payers as the Dividend Achievers (10 years of dividend increases) or Dividend Aristocrats (25 years of dividend increases).
However, MSFT’s three-year average dividend growth rate of over 10% is worth paying attention to, especially if it continues going forward. Currently there’s no reason to believe it won’t – the company has plenty of cash and no debt, and the current payout ratio (the annual dividend per share divided by the annual earnings per share) is less than 30%.
At the same time, it’s not entirely clear how committed the company is to its dividend. In a presentation to financial analysts last year, Microsoft’s CFO indicated that the company was hoping to achieve “a more predictable, steady, balanced dividend” and to “build a track record” in that regard.
However, he also indicated that with the share price where it was at the time (~$25), he’d be inclined to spend a marginal dollar of cash on a stock buyback, rather than an increased dividend. Still, both a stock buyback and a dividend hike were announced later in the year. Of course there’s always the risk that all of this could be out the window if the company pursues a large acquisition.
MSFT: A potential value play
Starting with the low earnings estimate of $1.66 per share for 2009 (from MSN Money) and a consensus five-year earnings growth rate of about 11% (and conservatively assuming 0% terminal growth thereafter), DCF analysis gives a fair value for MSFT of over $23. Dropping the five-year earnings growth rate to 6% gives a value of about $19 – just about where it was at the time of this writing.
Just for kicks I plugged MSFT into a couple of other DCF calculators, ValueCruncher and ValuePro, and using their default values received fair values of $27.22 and about $87(!), respectively. (The latter figure is probably a good example of the “garbage-in, garbage out” syndrome that so many analysts seem to fall prey to.)
Finally, a check with fundamental research provider Ockham Research shows MSFT rated as “greatly undervalued,” due to its price/sales and price/cash earnings ratios being well below recent historical values, as well as a dividend yield that’s above average historical levels. Overall then it would appear that MSFT may be attractively valued at current ($17-$19) or lower levels.
Technically “oversold” on long-term basis
A look at a 23-year price chart of MSFT shows the stock nearing the bottom of its long-term linear regression trend channel while also exhibiting extreme “oversold” readings on the price oscillators (shown in the middle two graphs). It’s important to note that while extreme oscillator readings can often indicate a near-term reversal in the stock price, they are indicators of strength in the direction of a given move and often also imply an eventual continuation of that move.
That said, an eventual move back down toward the ~$15 level – if it were to occur – would likely result in positive divergences on the long-term oscillators and might be viewed as an interesting long-term buying opportunity. A drop to the ~$15 level would also result in a dividend yield of about 3.5% (based on the current payout).
Bottom line
I’m currently short some LEAPS put options on MSFT and could ultimately end up being put the stock at $17.50. This position was initiated as a way of exiting a long MSFT stock position at higher prices (mid 20s) while at the same time allowing for the eventual recovery of the losses and/or the initiation of a new position in the stock at much more favorable levels.
Based on the above analysis, MSFT near its recent lows (~$17) or below seems attractive, and I’m comfortable with the idea of purchasing it for the long term at those levels (barring of course significant changes in the company’s fundamentals). If I didn’t currently have a position in the stock, I would currently be actively looking to initiate a position on a move back to or below its lows – either by buying the stock or by selling cash-secured puts.
For another take on MSFT, see the Microsoft Dividend Stock Analysis that was recently posted at Dividend Growth Investor.
