What To Know Before Buying Microsoft Corporation (NASDAQ:MSFT) For Its Dividend

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Today we'll take a closer look at Microsoft Corporation (NASDAQ:MSFT) from a dividend investor’s perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.” data-reactid=”19″>Today we’ll take a closer look at Microsoft Corporation (NASDAQ:MSFT) from a dividend investor’s perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

A slim 1.3% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Microsoft could have potential. The company also bought back stock during the year, equivalent to approximately 1.5% of the company’s market capitalisation at the time. There are a few simple ways to reduce the risks of buying Microsoft for its dividend, and we’ll go through these below.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content=" Click the interactive chart for our full dividend analysis ” data-reactid=”21″> Click the interactive chart for our full dividend analysis

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Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company’s net income after tax. In the last year, Microsoft paid out 40% of its profit as dividends. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Microsoft paid out a conservative 40% of its free cash flow as dividends last year. It’s positive to see that Microsoft’s dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Remember, you can always get a snapshot of Microsoft's latest financial position, by checking our visualisation of its financial health.” data-reactid=”37″>Remember, you can always get a snapshot of Microsoft’s latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well – nasty. For the purpose of this article, we only scrutinise the last decade of Microsoft’s dividend payments. During the past ten-year period, the first annual payment was US$0.52 in 2009, compared to US$1.84 last year. This works out to be a compound annual growth rate (CAGR) of approximately 13% a year over that time.

Dividends have been growing pretty quickly, and even more impressively, they haven’t experienced any notable falls during this period.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient’s purchasing power. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it’s great to see Microsoft has grown its earnings per share at 12% per annum over the past five years. A company paying out less than a quarter of its earnings as dividends, and growing earnings at more than 10% per annum, looks to be right in the cusp of its growth phase. At the right price, we might be interested.