Software giant Microsoft (NASDAQ:MSFT) has been consistently growing its dividend over the past decade, and today it's one of the best dividend stocks in the technology sector. Since 2005, the company has increased its payout at an annualized rate of about 14.4%, and its earnings cover the payment two-and-a-half times over.
It's always a good idea for dividend investors to look closely at the sustainability of a company's payout. Plenty of companies that seemed perfectly safe were forced to slash their dividends during the financial crisis, so it's important for investors to understand the risks facing the companies in their portfolio. Fortunately for Microsoft investors, the company's dividend is extremely safe, backed by ample earnings, an enormous cash cushion, and a wide economic moat.
Earnings and cash
An important number to consider when evaluating the sustainability of a company's dividend is the payout ratio. This is the percentage of net income that goes toward paying the dividend, and the higher the ratio, the more susceptible the dividend is to being cut if earnings decline.
Microsoft's payout ratio has been rising over the past decade, as the dividend has been growing faster than earnings, but it was still only 41% in fiscal 2014. This is low enough to not be a real concern, and Microsoft could safely push this number higher. In fiscal 2014, Microsoft earned $22 billion while paying out $8.9 billion in dividends, leaving about $13 billion for other purposes.
Meanwhile, the company is sitting on a mountain of cash. At the end of the most recent quarter, Microsoft had $89.2 billion in cash and cash equivalents, and only $23.7 billion in (mostly long-term) debt.
One wrinkle is that much of this cash is held abroad, and thus it can't be used to pay dividends unless it is brought back into the United States and taxed. However, this situation should not be a problem given Microsoft's earnings, and the fact that about half of the company's total revenue comes from the United States.
It would require an extreme deterioration of Microsoft's business for the dividend to be in any danger at all, and this seems unlikely amid the company's domination of the enterprise software industry.
While Microsoft's consumer business is often the target of criticism, the company's commercial business is stronger than ever before. Yes, the Xbox One video game console is struggling and Windows 8 remains unpopular among consumers, but Microsoft's enterprise software business is booming.
In the most recent quarter, for example, Windows volume licensing increased by 10%; Office commercial revenue grew by 5%, which is deceptively low since Office 365 is accounted for separately; and server products revenue grew by 13%. Cloud revenue, including Azure and Office 365, jumped 128%, and the gross profit generated from the enterprise business as a whole rose by 9%.
The strength of Microsoft's enterprise business is the key to the company's competitive advantage. Even if the consumer side remains weak, the enterprise side can more than make up for it. This strength protects Microsoft's dividend, as the company is not likely anytime soon to face a serious threat to its position as the leading enterprise software vendor. That's not so say there aren't any threats -- Google is pushing its productivity apps and Apple has teamed with IBM to better tackle the enterprise. But dethroning Microsoft will be no easy task given the switching costs involved.
An extremely safe dividend
Microsoft's dividend is about as safe as they get, thanks to a low payout ratio, a huge amount of cash, and competitive advantages in the enterprise segment that remain strong despite challenges from other companies. The current dividend yield, roughly 2.5%, has declined quite a bit as the share price has risen over the past couple of years, but it's still well above the S&P 500 average. Dividend investors looking for a high-quality dividend stock need to look no further than Microsoft.
Timothy Green owns shares of International Business Machines. The Motley Fool recommends Apple, Google (A shares), and Google (C shares). The Motley Fool owns shares of Apple, Google (A shares), Google (C shares), International Business Machines, and 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.