Over the past few years, technology stocks have emerged as a fantastic source of dividend payers. This couldn't come at a better time, as investors in the post-2008 era are clamoring for the stability of quarterly dividends. There's a boatload of evidence to suggest the true power of dividends, and during bear markets, dividends serve as a meaningful source of downside protection, while during rising markets, they add to total returns.
Sometimes, technology stocks get left out of conversations about the market's best dividend stocks. But, Microsoft (NASDAQ:MSFT) is certainly one that fits the bill and deserves your attention if you're on the hunt for a great dividend stock. Microsoft and other technology companies like Cisco (NASDAQ:CSCO) have transformed themselves into premier dividend payers in just the past few years.
Strong free cash flow
Microsoft is a true gem, partly because of its ability to generate huge free cash flow. Microsoft enjoys the benefit or racking up strong revenue and profits without having to spend much in capital expenditures. This results in fat margins across Microsoft's businesses, and the results speak for themselves.
Microsoft recently wrapped up its fiscal third quarter, in which it collected $5.6 billion in profits. Turning to its statement of cash flows reveals the company's hugely successful operations. Over the first nine months of the fiscal year, Microsoft has already generated more than $18.5 billion in free cash flow.
This goes a long way toward its ability to pay hefty dividends to shareholders. On a per-share basis, Microsoft produced $2.20 per share in free cash flow over the last nine months, and paid just $0.84 per share in dividends during this time.
It's worthwhile to analyze the company's free cash flow payout ratio, which is a purer measure of its operating power than the traditional payout ratio alone because it strips out non-cash items like depreciation.
Viewing Microsoft's dividend sustainability through this lens reveals it paid out just 38% of its free cash flow over the past nine months. Therefore, it's clear that Microsoft not only generates enough cash flow to support its current payout, but that its strong dividend growth over the past few years. Moreover, this should allow for plenty of hefty dividend increases going forward.
Fortress balance sheet
The second core ingredient that forms the recipe of success for Microsoft is the quality of its balance sheet. This is true for both Microsoft and Cisco.
At the end of the most recent quarter, Microsoft held more than $88 billion in cash and cash equivalents. That works out to roughly $10.50 per share. This provides valuable insulation against adverse business conditions.
It's worth noting that Microsoft and Cisco hold a lot of their cash overseas, as many large technology companies nowadays generate the majority of their sales and profits from international markets. In some instances, they're leveraging their stellar balance sheets by issuing debt, to finance their generous dividend payouts.
Cisco made headlines earlier this year when it sold $8 billion worth of bonds, which at the time was the biggest debt sale of 2014. Cisco has raised its dividend four times since instituting its dividend payments three years ago.
Put Microsoft on your radar
If you're on the hunt for a dividend-paying stock with tons of cash on the balance sheet and the ability to rack up boatloads of free cash flow to support its dividend, look no further than Microsoft. Because the company's services generate fat margins without requiring huge capital expenditures, Microsoft almost has more cash than it knows what to do with.
Microsoft has increased its dividend by 16%, compounded annually over the past five years, and yields 2.8%. The company has more than enough flexibility to keep increasing its dividend at similar rates in the future, thanks to its ability to generate strong free cash flow. As a result, Microsoft has everything you need if you're looking for a great dividend stock.
Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.