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Attendees play with Microsoft Corp.'s Xbox 360 game console during the Consumer Electronics Show in Las Vegas, on Wednesday, Jan. 11, 2012. (David Paul Morris/Bloomberg)
Attendees play with Microsoft Corp.'s Xbox 360 game console during the Consumer Electronics Show in Las Vegas, on Wednesday, Jan. 11, 2012. (David Paul Morris/Bloomberg)

Yield Hog

Microsoft: A Window on rising dividends Add to ...

Anil Tahiliani had heard all the trash talk about Microsoft : It’s too big and slow; it doesn’t know the meaning of innovation; it’s going to get eaten alive by Google and Apple .

Apple boss Steve Jobs, who made a sport of bashing Microsoft, summed it up best in his posthumously released biography: “They’ve become mostly irrelevant.”

But as Mr. Tahiliani pored over Microsoft’s financials last fall, the portfolio manager with McLean & Partners Wealth Management in Calgary came to a different conclusion.

Pessimism dogging the software giant had gotten so extreme that the stock was a screaming bargain, he thought. So, in November, he bought shares – a move that turned out to be prescient.

“It was an out-of-favour stock,” he said. “But there was a lot of fundamentally positive stuff.”

Judging by the 20-per-cent rebound in the shares since then, investor sentiment toward Microsoft may finally be changing for the better.

Anticipation of the Windows 8 launch later this year for PCs and mobile devices is one reason. Another is that the new Windows-based smartphones, produced in an alliance with Nokia, are drawing praise from reviewers accustomed to slagging Microsoft products.

What’s more, strong growth from Microsoft’s other divisions including servers and tools, business (which produces Microsoft Office, among other products) and entertainment (XBox) are contributing to a sense that the company may be turning the corner.

That point was driven home by fiscal second-quarter results released on Jan. 19. Even as Windows sales slipped 6 per cent, partly reflecting component shortages caused by flooding in Thailand, overall revenue climbed 5 per cent to $20.9-billion (U.S.) and profit of $6.62-billion, or 78 cents a share, came in slightly ahead of estimates.

For dividend investors, in particular, Microsoft has a lot of pluses. It produced more than $26-billion in free cash flow in the past 12 months, and it’s sitting on about $51.7-billion, or more than $6 a share, of cash and short-term investments – more than enough to fund share buybacks and dividends.

While the yield of 2.7 per cent won’t make you rich overnight, Microsoft has steadily raised its dividend since shelling out its first payment in 2003. That includes a hefty 25-per-cent bump in September. It also paid a sizable special dividend of $3 a share in fiscal 2005. Given the company’s dividend growth record, ample cash reserves and consistent profitability, those dividend hikes will almost certainly continue well into the future. If anything, investors would like to see the company accelerate the pace of dividend increases.

As for valuation, even after the stock’s 20-per-cent run the shares aren’t expensive for a company of Microsoft’s stature, particularly given the growth kickers of Windows 8 and the Nokia partnership. The shares trade at a multiple of 10.8 times estimated fiscal 2012 earnings, but if you subtract the $6 in cash on the balance sheet from the stock price, the P/E falls to about 8.6.

That said, analysts don’t see a huge upside in the stock price over the next 12 months, perhaps because the benefits of Windows 8 will take longer than that to fully materialize. According to Bloomberg, the average price target is $31.37 – about 7 per cent higher than Tuesday’s close. Of the 41 analysts who follow the company, 26 call Microsoft a “buy”, 14 a “hold” and one a “sell.”

Is Microsoft a slam dunk? No. In the fast-changing technology market, companies can be in favour one minute and in the doghouse the next. Just ask a Research in Motion shareholder. But given the breadth of Microsoft’s products and services, its dominance in certain markets and its prodigious cash flow, it’s a conservative choice for investors who want exposure to the technology sector and the virtual certainty of growing dividends.

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Follow on Twitter: @johnheinzl


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