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Is Microsoft's Dividend Raise Reason to Buy?

By Bob Ciura - Sep 17, 2013 at 9:00PM

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Microsoft announced a huge dividend increase and share buyback authorization, yet shares didn't rally to the extent one would expect. That's likely because the company still has important questions to answer.

A great deal of buzz surrounded the technology sector when it was revealed that Microsoft (MSFT 1.70%) had unleashed a new wave of cash on its shareholders. The software king authorized a gigantic share buyback authorization in addition to a huge dividend increase. Shareholders rejoiced on the news, as an increasing number of technology investors are embracing the merits of returning cash to shareholders.

At the same time, there's a sense of hollowness to Microsoft's announcement, as recent news pertaining to its underlying business has been less than impressive. What are investors to make of Microsoft's cash deployment? Are the dividend and buyback reasons to buy the stock, or is a dose of caution warranted here?

Technology giants, flush with cash
All told, Microsoft announced its board of directors had approved a 22% dividend increase, as well as a new $40 billion share repurchase authorization. Microsoft was nearing the expiration of its existing share repurchasing program, and it had been a year since its last dividend increase. As a result, it wasn't entirely a surprise that Microsoft would revise its two capital allocation programs. What was surprising, though, was the size of the dividend increase and new buyback.

Since the financial crisis, investors have widely clamored for increased dividend payments and share repurchases, even within the technology sector. Tech stocks used to have no association whatsoever with dividends, which were primarily reserved for stodgy utilities or consumer staples stocks. However, after the brutal 2008 market meltdown, investors are quickly changing their tune, and are expecting a fair share of cash from their equity investments.

Microsoft has joined other technology stalwarts, including Intel (INTC 1.46%) and Cisco Systems (CSCO 1.55%), among the dividend-paying rank and file. All three technology giants have ratcheted up their payouts in recent years, after spending many years offering little to nothing in terms of yield.

Intel carries one of the highest yields in the Dow Jones Industrial Average, despite being a technology stock. The company yields a compelling 3.8%, and last year provided investors with a 7% dividend increase. Not to be outdone, Cisco has made great strides in its shareholder return policy: After instituting a dividend in 2011, the company has nearly tripled it since then. The stock yields a healthy 2.8% at recent prices.

These technology stocks have strong balance sheets flush with cash and little to no debt to service. As a result, they more than have enough financial flexibility to bump up their returns to shareholders. Even with their market-beating yields, both Intel and Cisco hold payout ratios less than 50%, meaning there's still plenty of room to increase their distributions going forward.

Investors are likely excited by Microsoft's compelling dividend increase and new share buyback program, and rightly so. Studies have routinely shown that dividends have represented a large portion of total return over the past several decades. Moreover, in an investing environment in which interest rates remain at very low levels and yield is hard to come by, Microsoft's new 3.4% yield is extremely attractive for investors starved for income.

Curb your enthusiasm
At the same time, I believe a dose of caution is warranted. Microsoft still has fundamental questions surrounding its core business that remain unanswered. Specifically, the company has not yet proven it has a viable strategy to get its products and services away from the traditional personal computer industry. PC shipments are falling, and growth in computing going forward is clearly in the mobile space, an area in which Microsoft is quickly falling behind.

Microsoft has thrown billions of dollars at the problem, acquiring various companies that it hopes can finally give it some mobile market penetration. These efforts have failed to produce anything meaningful so far, and it's gotten to the point that the company is simply grasping at straws. Consider Microsoft's recent spending spree: $8.5 billion to acquire Skype in 2011, $1.2 billion the following year for social media player Yammer, and most recently, $7.2 billion for Nokia's smartphone business.

Microsoft's bread-and-butter software and services make it a cash cow. However, the future is cloudy, and the company is still carrying businesses that are woefully under-performing. Microsoft continues to bleed money in its Online Services division, which is responsible for the Bing search engine and MSN. That division booked an $8 billion operating loss in fiscal 2012.

Put simply, Microsoft needs to demonstrate that it can remain strong in the post-PC world. As a result, while I love dividends as much as the next investor, I'm content to wait on the sidelines until the questions surrounding Microsoft's underlying business are more satisfactorily answered.

Robert Ciura owns shares of Intel. The Motley Fool recommends Cisco Systems and Intel. The Motley Fool owns shares of Intel 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.

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Stocks Mentioned

Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$291.91 (1.70%) $4.89
Cisco Systems, Inc. Stock Quote
Cisco Systems, Inc.
CSCO
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Intel Corporation Stock Quote
Intel Corporation
INTC
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