Microsoft Is a Cash- and Dividend-Generating Machine

Rodney Nelson: Although share repurchases have been the dominant method of capital returns in technology, Microsoft has been one of the most consistent dividend payers in the sector. Microsoft's wide-moat business--anchored by flagship cloud properties such as Azure and Office 365 and legacy franchises such as Windows--is a cash-generating machine, supporting consistent annual growth in its dividend. In the last 10 years, Microsoft has more than doubled its annual dividend payment, and the firm recently announced a 7.6% hike payable this December, which would imply a yield of roughly 2.2% at current market valuation.

While Microsoft's dividend yield is certainly not extraordinary, the firm has remained committed to its capital return program, which encompasses both a healthy dividend and frequent share repurchases. These channels have resulted in nearly $200 billion in capital returns to shareholders over the last 10 years. We model consistent 7% annual growth in dividend payments over the next 10 years, which would yield roughly $165 billion in capital returns by itself and imply an annual payout ratio consistently between 40% and 50%.

Further, we believe the market is undervaluing Microsoft's core business. The stock trades at a roughly 10% discount to our $83 fair value estimate. We think the market does not fully appreciate the upside opportunity in Microsoft's cloud business. Azure, Microsoft's public cloud offering, represents a massive growth opportunity for the company, which gives Microsoft access to what we believe will be a $200 billion market within the next five years. We believe Microsoft has succeeded in establishing itself as one of two strategic long-term cloud vendors for the world's largest enterprises alongside Amazon Web Services, and these firms should continue to attract the bulk of business in this burgeoning market.