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The Power of Growing Dividends
Dividends that consistently outpace inflation can significantly boost wealth over time. Although artificial intelligence (AI) stocks are not traditionally recognized for their dividend yields, some tech giants in this sector are beginning to distribute dividends and are even increasing them at double-digit rates.
Microsoft’s Notable Dividend Increase
On Monday, Microsoft, the most longstanding dividend payer among major AI tech stocks, announced an impressive dividend hike exceeding 10%. Here’s what you need to know about Microsoft’s latest payout enhancement for shareholders.
Microsoft has declared a rise in its quarterly dividend from $0.75 to $0.83, marking a 10.7% increase. This adjustment will be effective for the December payout, benefiting stockholders as of November 20, with the ex-dividend date set for November 21. Despite this hike, the new dividend yield at the current share price is approximately 0.8%.
In tandem with the dividend increase, Microsoft has sanctioned a $60 billion share buyback initiative. When a company repurchases its shares, the share count is reduced, thus amplifying the ownership stake of the remaining shareholders. However, considering Microsoft’s current market capitalization, this buyback represents a modest reduction of about 2% of its shares.
Sustainability of Dividend Increases
While the returns for shareholders might seem modest, the increases this year appear sustainable and likely to be repeated. Despite the dividend hike of nearly 11%, Microsoft’s diluted earnings per share surged by 22% over the past fiscal year. Consequently, the dividend payout ratio relative to earnings will actually decrease, creating additional room for future payout increases.
Microsoft’s robust financial health supports this growth, boasting $75 billion in cash and only $50 billion in short- and long-term debt. This financial cushion persists even after the substantial $69 billion all-cash acquisition of Activision Blizzard, finalized last December. The acquisition is expected to further enhance earnings in the coming year, as it only impacted half of Microsoft’s previous fiscal year. Nevertheless, the core drivers of Microsoft’s earnings growth will remain its AI-driven cloud computing and business productivity software sectors.
Potential Risks to Dividend Expansion
Despite the positive outlook, Microsoft may not allocate the entire $60 billion toward share repurchases this year. Cash flow could be a concern, as cloud giants, including Microsoft, are investing heavily in AI data centers. Notably, Microsoft’s free cash flow last year was $74 billion, lower than its net income of $88.9 billion.
In the fourth quarter, Microsoft spent $13.9 billion in cash on capital expenditures. If this trend continues, annual capital expenditures could rise to $56 billion, a significant increase from last year’s $44.5 billion. This figure is likely to grow further in fiscal 2025, as the AI competition shows no signs of abating.
The company is also projected to generate increased AI-related revenue in the coming year. For example, Microsoft charges $30 per seat for its AI-enhanced Copilot version of Microsoft 365. During a recent conference call, CEO Satya Nadella highlighted that Office 365 Copilot users grew by 60% quarter over quarter, with Copilot for GitHub contributing 40% of that segment’s growth. However, any success in AI would likely lead to increased spending on AI data centers, potentially reducing free cash flow relative to earnings this year.
Reflecting on the previous year, Microsoft spent only $17.2 billion on share repurchases, lower than the $22.2 billion the year prior. Therefore, it seems improbable that the company will repurchase $60 billion worth of shares this year. Last year’s conservatism, which facilitated the Activision acquisition, may also have been intended to conserve cash for substantial AI investments. Additionally, at 36.5 times earnings, Microsoft’s stock isn’t particularly cheap, limiting the impact of repurchases.
Both the expenditure on AI and the high valuation may lead to cautious management decisions in 2025, leaving a significant portion of the $60 billion unspent.
Implications for Investors
The dividend increase may not attract investors primarily focused on yield, but it could benefit long-term shareholders. Newer investors should view Microsoft as a growth stock with a small dividend bonus, hoping that AI advancements will significantly boost revenue and earnings despite the company’s large scale.
For dividend-focused investors seeking substantial payouts in the near future, waiting for a stock price pullback may offer a better opportunity for entry.
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