Forget Starbucks: Microsoft Is the Better Dividend Growth Stock

After this month's incredible rally, investors on the sidelines may feel as if they've missed the boat. With the U.S. economy reopening and adding jobs again, the "out-of-home" plays have skyrocketed recently, as they were among the hardest hit in March's sell-off.

Meanwhile, technology stocks, after a nice run earlier in the year, have stagnated as investors rotate into more beaten-down sectors of the economy. However, technology is pushing many of the big societal trends today, from 5G communications, to cloud computing, to artificial intelligence, to e-commerce, telemedicine, remote work, and remote education. Thus, tech may also be worthy of a look after its "pause."

So, what kind of stocks should you buy today, if putting new money to work? First, whether it's an out-of-home or work-from-home stock, make sure to invest in a quality business. The times are still uncertain, and with many lower quality stocks having rebounded sharply off the lows, it's probably a good time to look at some of the larger, high-quality dividend stocks in the market. 

After all, companies with sustainable competitive advantages and solid growth prospects are almost never a bad buy. Meanwhile, it's also a great time to buy dividend growth stocks. With interest rates at rock-bottom levels for the foreseeable future, even low dividends look attractive today. And if those dividends can grow? Even better.

One large, high-quality out-of-home dividend stock is coffee giant Starbucks (SBUX 0.88%), while a favorite high-quality work-from-home stock is Microsoft (MSFT 2.34%). Let's see which of the two looks better today.

Images source: Getty Images.

COVID-19 hit Starbucks hard

Investors may be tempted to buy Starbucks as it recovers from the COVID-19 pandemic. While Microsoft's first calendar year quarter's earnings were relatively unaffected by the coronavirus, Starbucks was, predictably, heavily affected.

Though lockdowns occurred only in the last two weeks of the March quarter in the U.S., Starbucks' Americas segment saw a 3% decline in same-store sales. More indicative of the quarantine-affected results was the company's international segment, which includes China, which saw a 31% same-store-sales decline. Offsetting these declines was an increase in Starbucks' channel development, where Starbucks sells beans and pods through third-party retailers like grocery stores, which saw 16% sales growth, though off a much, much smaller base. Yet the channel improvement wasn't enough to offset declines in stores, as the company saw negative deleveraging as it continued to pay employees through the period. As a result, Starbucks saw its earnings per share fall by 47% in the March quarter, down from $0.53 a year ago to just $0.28 last quarter.

Moreover, that quarter was only partially affected by the coronavirus. Even as more and more Starbucks stores reopen, results are likely to be worse in the current quarter. And though Starbucks has already reopened basically all its stores in China, they are operating under modified hours. While 85% of Starbucks' total stores have reopened, the company hasn't been able to give employees as many hours as expected and recently encouraged workers to take unpaid leave -- not a great sign.

Clearly, Starbucks is a great company and is doing the right thing by continuing to offer its benefits to workers, even if they're on leave. However, that will affect near-term results. Analysts now expect Starbucks to post a net loss of $0.16 for the June quarter, and just $1.37 for the fiscal year ending in September. That $1.37 is actually lower than the company's current $1.64 dividend, so Starbucks will likely have to fund its dividend with more debt as well as it navigates through this period.

Microsoft is well insulated

While Microsoft will also be affected by any economic slowdown, it has a far more resilient business model. That's because Microsoft mainly operates in enterprise software, which businesses need to use in good times and bad. While it's true that a recession could lead to a decrease in business IT investment, the COVID-19 pandemic has also spurred many business to digitize their IT infrastructure much faster than they otherwise would have. That cross-current of headwinds and tailwinds left Microsoft's recent results on-trend during the March quarter.

In fact, Microsoft's year-over-year growth actually accelerated during coronavirus compared to the December quarter, led by its Azure infrastructure-as-a-service platform, which grew a stunning 59%. Microsoft's Teams software, which competes with coronavirus darlings Slack Technologies (WORK) and Zoom Video (ZM 1.10%) got a big boost in interest as workers began to work from home across a wide swathe of businesses. "We've seen two years' worth of digital transformation in two months" said CEO Satya Nadella on the recent conference call with analysts.

With Microsoft's high-growth cloud-based products making up a larger part of the business, and with Microsoft's new Xbox console set to launch later this year, it's possible that Microsoft can maintain or even accelerate its revenue and earnings through 2020.

Yet valuations are similar

Despite Microsoft clearly having the better-insulated business, growth prospects, and a better balance sheet, both companies actually trade at similar valuations at this point. While it's not always appropriate to compare companies in different sectors, when looking at each company's financial characteristics, it's hard to believe both are valued so closely, at least on a forward price-to-earnings basis.

Data source: company filings and Yahoo! Finance. 

Microsoft is actually slightly cheaper based on 2021 EPS estimates, and Starbucks' 2021 estimates imply a significant recovery from current levels. No doubt, a Starbucks recovery will likely happen, but the scope of the recovery is still a big question mark. And while Starbucks' dividend is currently covered by trailing earnings, remember, its 2.08% dividend will likely not be covered by 2021 full-year earnings. Even using the $2.75 EPS estimate for next year, and the dividend payout ratio would rise to 60%, up from 55% today. That doesn't leave much room for more growth or debt paydown, which will likely be necessary considering the company has taken on additional debt to get through this period.

Meanwhile, not only is Microsoft cheaper on forward earnings basis, but when taking into account its massive $71 billion in net cash versus Starbucks' $11.4 billion in net debt, Microsoft is significantly cheaper. In addition, I think analysts may be too conservative with Microsoft's earnings growth estimates, which only imply 9.1% growth next year. Given that Microsoft grew earnings per share 23% last quarter and 28% over the past nine months, I think that's much too modest, given the company's strength in cloud computing.

Putting new money to work? Microsoft looks better

While many investors may see Starbucks' higher dividend yield and think its top brand will make for a good reopening play, the company's strong recovery from the March lows seems to have priced in a lot of the good news already. Meanwhile, I think Microsoft still has more gas left in the tank, based on its stronger financials. Analysts at Wells Fargo (WFC 0.66%) recently raised their price target on Microsoft to $250, up from $188 today, and I think that's a solid call.

Of course, I own both companies. Starbucks isn't a bad investment by any means. However, when looking at each company's growth and profit potential amid the coronavirus, along with their strikingly similar valuations, it's no contest: Microsoft seems like the better of the two investments today.