Microsoft (MSFT -0.14%) raised dividends last week, increasing payments by a vigorous 16% annually to $0.36 per share. This brings its dividend yield to a respectable 3.3% versus the current stock price. Not only that, the company looks well positioned to continue to increase dividends in the future, and this has major implications for investors in the stock.
Positioned for dividend growth
Microsoft has raised dividends in each and every year since making its first payment in 2003. Management is deeply committed to rewarding investors with growing payments over time, and the business generates more than enough cash flows to finance distributions.
During the fiscal year ended on June 2015, Microsoft brought in $29.1 billion in operating cash flow. Capital expenditures absorbed nearly $5.9 billion of that money, leaving $23.2 billion in free cash flow. Dividend payments amounted to $9.9 billion, or only 43% of free cash flow generation through the year.
Microsoft is allocating tons of capital to share buybacks, investing $14.4 billion in share repurchases last year. This reduces the outstanding share count over time, allowing it to pay higher dividends per share with the same amount of money. Buybacks are taking resources away from dividend payments right now. However, more buybacks today are setting the stage for growing dividends tomorrow.
Since Microsoft is a big and stable company, it's not easy for management to find growth opportunities. In addition, new industry trends such as the rise of mobile and cloud computing represent a considerable challenge in terms of adapting to customer needs. However, Microsoft is making progress in several key areas.
The commercial cloud segment surpassed the $8 billion annualized run rate last quarter, a whopping increase of 88% year-over-year, and management plans to produce $20 billion in annual revenue from this division by fiscal 2018. Office is also doing remarkably in a changing industry landscape, Microsoft has over 15 million Office 365 commercial customers as of the last quarter, and new customers are signing in at a rate of nearly 1 million new customers per month.
The recently launched Windows 10 has received mostly positive reviews from the specialized media. It won't be easy for Microsoft to jump-start sales in the Windows division. However, launching a better version of the company's iconic operating system is clearly a solid first step.
Growing dividends for superior returns
Dividends offer many advantages for investors. To begin with, cash payments provide recurrent income from your portfolio, this means more stable and predictable returns, and it can be an enormously valuable trait for those with specific income needs, such as investors approaching retirement.
Even more important, growing dividends say a lot about the health of the company. In order to pay sustainably growing dividends over the years, a business needs to produce consistently increasing cash flows. Also, when management is raising dividends, this generally signals strong confidence on the company and its prospects. In fact, according to different studies, dividend growth companies tend to outperform the market in the long term.
Analysts at Goldman Sachs studied the returns of different kinds of stocks from Jan. 31, 1972, to Dec. 31, 2014, and the conclusions from this report are quite interesting. Dividend-paying companies tend to outperform their non-dividend paying counterparts by a considerable margin: A $10,000 investment in non-dividend paying stocks would have turned into $30,316 by the end of the period, while the same amount of capital invested in dividend stocks would have turned into a much bigger $461,904.
Still, companies with consistent dividend growth did even better. A $10,000 investment in companies starting new dividends or raising their payments every year would have turned into $630,024 by the end of the period, comfortably beating both companies with stable dividends and those paying no dividends at all.
Microsoft is well positioned to continue to reward shareholders with growing dividends over the years, and this could be a powerful return driver for investors in Microsoft stock.