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After Its Earnings Miss, Mr. Softy Could Be a Big Buy

Aaron Levitt May 04, 2016


For dividend investors, the technology sector is quickly becoming the sector for dividend growth. Leading that charge has been software and hardware stalwart Microsoft (MSFT ). As one of the survivors of the dot-com bust, Microsoft has become dividend royalty, plowing more cash back into investors’ pockets each and every quarter.


However, Mr. Softy didn’t exactly act like royalty during its latest earnings release.

After putting up poor numbers, some analysts and investors have questioned MSFT’s future as a profit-making machine, and more importantly, its future as a dividend machine. The company does have a few major headwinds pushing back.

But for patient investors, this could provide a great buying opportunity to snag MSFT shares and its 2.80% dividend yield.


The Bad News at MSFT


The bad news at Microsoft can be found inside its latest earnings release. And that weakness comes down to PCs. It’s no secret that MSFT is the dominant player in personal computing software and operating systems. Its Windows line up of operating systems is as timeless as the PC itself. As such, Windows is the dominant operating system for computers with around 88% market share.

The problem is that no one is using a computer anymore. Okay, that’s not entirely true, but we certainly aren’t using as many. Tablets, smartphones, and other devices are replacing the need for multiple PCs in a household. Personal computer sales dropped nearly 8% in 2015, down to just 289 million units. That follows a similarly big decline in 2014.

Even worse is that new entrants like Apple (AAPL ) and Google (GOOG ) have also started to meaningfully chip away at Microsoft’s dominance in the PC world. So not only are consumers buying fewer PCs, they’re buying PCs that don’t run Windows.

Fewer PCs means less licensing revenue and profits. That was certainly apparent for MSFT during its latest results and rare estimate miss.


Focus on the Transition


With PC sales falling by the wayside, it would be easy to call MSFT a tech dinosaur, worthy of shorting into the ground. But that simply isn’t the case. Would-be investors need to keep repeating two words to themselves: Satya Nadella.

Since becoming CEO of MSFT, Nadella has moved the company into newer avenues of growth beyond operating systems.

That includes moving towards the cloud. Amazon (AMZN ) is still the dominant player by revenues when it comes to the cloud, but MSFT is the fastest growing. The latest quarter saw Mr. Softy see a huge 120% increase in Azure cloud services revenues. Though margins in the businesses remain low, MSFT has the knowledge and ability to sell products on volume. Integration of Azure is easier as well versus its rivals as most things are hosted on Windows platforms anyway.

Microsoft is winning the war in cloud computing in other ways as well. Office 365, the SaaS version of its popular productivity suite, has seen subscriber counts leap, resulting in higher revenues for the division. MSFT has also expanded in recent weeks into offerings combining its Azure platform with Internet of things (IoT) capabilities as well as releasing a new version of Windows, Windows 10 IoT Core, designed to analyze data.

Finally, Microsoft may have finally figured out the hardware game. After losing out on mobile because it was late to the party, MSFT has become a tablet champion. Its Surface line up of tablets continues to take market share away from Apple’s iPad and win awards for design. Even its Xbox and entertainment division has seen rising subscribers and revenues as the devices have moved beyond being a video game console into a full entertainment/shopping hub.


Boosting Its Dividend


So while MSFT’s former bread and butter is on the decline, investors may not need to worry about PCs. Mr. Softy still has plenty of avenues to grow its juicy dividend over the long haul. Something it’s already done.

Since launching a dividend, the tech firm has raised it every year. Over the last five years, MSFT has raised that payout by 17% annually. The real key for investors is that MSFT’s payout ratio is a low 52%, meaning that Microsoft has plenty of room to grow its payout solely based on its earnings.

As the firm transitions to the cloud and becomes more of a service company, those growing revenues will begin to trickle down into MSFT’s bottom line and ultimately, into investor’s pockets as dividends. It already has the room to pay more. So adding more cash to that mix pretty much guarantees a higher dividend payout down the road.

Meanwhile, MSFT’s $115 billion in cash and short-term investments on its balance sheet helps it get over any bumps in the road, like this earnings report, until Azure and the cloud really take off.


The Bottom Line


MSFT’s earnings miss highlights its main problem: declining PC sales. However, the firm continues to move away from focusing on operating/productivity software and into faster moving areas such as cloud computing and IoT applications. Ultimately, that will be what drives Microsoft’s dividend into the future. Investors can use the recent misstep to snag shares of the leading tech stalwart and collect its juicy dividend as the transition goes through.

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