Income investors hungry for dividends are in a difficult position. On the one hand, typical income-generating securities like fixed-income offer puny yields as a result of extremely low interest rates. On the other hand, equities aren’t much better, since the stock market is still hovering near all-time highs, and the stocks that comprise the S&P 500 index yield only around 2% on average.
Fortunately, there are still a select few dividend stocks that offer the combination of a high dividend yield along with strong free cash flow to support rapid dividend growth.[ad#Google Adsense 336×280-IA]One such company is Microsoft (NASDAQ: MSFT).
Microsoft generates huge free cash flow, and uses it to reward its shareholders with a hefty 3% dividend yield, as well as high dividend growth each year.
Microsoft is truly a cash machine.
It is currently halfway through its fiscal year, and the company generated $9.9 billion of free cash flow in this period.
It paid $4.8 billion of dividends in that time, meaning it distributes less than half of its free cash flow.
That is a very comfortable level that allows the company to reward shareholders with an above-average dividend, and still have plenty of cash flow left to reinvest in the business for future growth.
Indeed, Microsoft’s growth profile looks very strong, thanks to its fundamental strategy of aggressively pursuing new high-growth businesses. This tactic separates Microsoft from some of its peers in the tech space like Hewlett-Packard (NYSE: HPQ) and Intel (NASDAQ: INTC). All three of these companies built their fortunes around the personal computer and its related products, and are still too reliant on these low-growth areas.
For instance, HP still derives around 20% of its annual revenue from printers. It’s no secret that printers aren’t selling nearly as well as they used to, as HP’s printing revenue fell nearly 4% last year.
Intel still derives nearly two-thirds of its revenue from its personal computer segment. This is problematic, since global PC shipments are slowing down due to an increasing amount of computing being performed on mobile devices. In fact, Intel’s PC revenue was lower in 2014 than in 2012.
But while HP and Intel haven’t made much progress breaking away from the PC, printers and other “old tech” businesses, Microsoft has fully embraced the cloud revolution. Last quarter, Microsoft’s Office 365 Home and Personal subscribers jumped 30% to over 9.2 million. Because of this, Microsoft’s commercial cloud revenue soared 114%, to a $5.5 billion annualized revenue run-rate.
Separately, Microsoft has a variety of other businesses that are each growing and contributing positively to results. Devices and consumer revenue grew 8% to $12.9 billion last quarter. It sold 10.5 million Lumia phones, helping boost phone hardware revenue to $2.3 billion. In addition, tablet revenue grew 24%, driven by the success of the Surface Pro 3.
Because of this revenue growth, Microsoft has grown its dividend at a much faster rate than its closest competitors in the technology sector. Over the past five years, Microsoft grew its dividend by 18% compounded annually. By contrast, Intel’s dividend growth is less than half that in the same period. HP recently increased its dividend by 10%, although the stock yields just 2.25%, significantly lower than Microsoft’s 3% yield.
Another reason to love Microsoft is its bulletproof balance sheet. At the end of last quarter, the company held $90 billion in cash and marketable securities on its balance sheet, with a very healthy 20% long-term debt-to-equity ratio. Moreover, Microsoft is one of only three U.S. companies to hold the coveted triple-A credit rating from Standard & Poor’s.
Microsoft’s fundamentals are in excellent shape, thanks to its strong growth in exciting new business areas such as the cloud. Furthermore, the company is in extremely sound financial position.
As the company continues to rake in free cash flow, with little debt and low capital expenditures, all that cash is piling up on its balance sheet. This should allow the company to continue raising its dividend at very high rates going forward, making Microsoft an excellent pick for dividend investors.
— Bob Ciura[ad#wyatt-income]
Source: Wyatt Investment Research