Sometimes, 16 cents can have great implications for the market.
After 16 years,
decided last month to share its monopoly money, offering shareholders an annual cash dividend of 16 cents a share. The news, coming close upon the heels of President Bush's proposal to eliminate the "double taxation" of dividends, helped renew investor interest in dividends. While Microsoft critics lamented that the payout signaled the company's heady growth days are over (which is true), others viewed the news as very positive.
"This idea that Microsoft is doing this because it doesn't see as many investment opportunities is really shortsighted," said Jeremy Siegel, professor of finance at the University of Pennsylvania's Wharton School and author of
Stocks for the Long Run
. "This dividend is a great idea, and Microsoft is moving in the right direction."
For individual investors, it's a good time to revisit dividends; consider how the Microsoft dividend may help further alter the investment landscape.
1. Discovering the Dividend
Many investors, journalists, chief executives and money managers seem to have just discovered dividends. In fact, they've been around for as long as exchanges: The first payment of dividend was made by the Dutch East India Company in 1610, according to Amsterdam Stock Exchange archivist Marion Redeker-Hesseling.
For the better part of the 20th century, dividends were high on investors' radar screens. The market's dividend payout ratio -- which measures the percentage of a company's earnings paid out in dividends -- averaged about 57% during the past 75 years, but that level fell to a historic low of 31.78% at the end of 2000, according to a June 2001 study by Ibbotson Associates. Meanwhile, the dividend yield was at 5.15% in 1926 and fell to 1.1% at 2000's end.
Why did investors and companies forget about dividends during the go-go bubble of the 1990s? "People didn't focus on dividends because they were looking for short-term gains," said Marshall Acuff, the recently retired Salomon Smith Barney strategist and founder of consulting firm AMA Investment Council. "And companies listened to some academics that said, 'Why pay out dividends? If you put that money back in the company, you can grow more.'"
Many companies -- especially growth and tech companies -- passed on dividends, opting to funnel their money into their growth prospects.
2. The Long-Term Returns
Microsoft's move is the boldest signal yet that the perception on dividends is changing. Investors should be happy: In the Ibbotson study, dividends made up for more than 40% of return on equities.
When you factor in compound annual growth, it gets even better. According to Acuff, $1 invested at the end of 1925 would've grown to $1,781 by the end of October 2002 -- that's total return, assuming dividends get reinvested. If you took that same $1 but looked only at capital appreciation -- removing the long-term benefits of dividends -- you have $69.
Microsoft's decision sheds more light on the long-term benefits of dividends and may spur more investor and corporate interest in payouts.
Maturity used to be a dirty word for technology investors. It means you've stopped growing rapidly. The common wisdom back in the 1990s was that companies like
and Microsoft could post 40% earnings growth forever -- even though it meant they would represent about half of the U.S. GDP by 2008 or so.
Nothing spelled "mature" more than dividends. Dividends were for widows and orphans, REITs and utilities -- not for growth investors and tech stocks. So, is Microsoft's dividend an acknowledgement that it has reached the stage of "mature growth?" Absolutely.
However, anyone who waited until now to realize that Microsoft's growth was inevitably slowing has been missing a lot of signals -- not to mention disregarding the law of large numbers. Even with "slowing growth," a 10% increase in revenue for a company with $28 billion in revenue during fiscal 2002 -- in this environment for tech stocks -- is no small feat. Yes, Microsoft gave cautious guidance for the coming year. But it always gives cautious guidance. The stock's price-to-earnings multiple, in the low 30s, may be cause for concern, but the company and many analysts were quick to throw water on the notion that Microsoft is no longer a growth company.
4. It's Over
That said, Microsoft's dividend should drive home the point to any investors who still harbor hope that technology will soon resume its role as the market juggernaut. The unprecedented, tech-led bull run that began in 1982 and reached a frenzy in the late 1990s was a once-in-an-investing-lifetime thing based partly on reality -- technology went from 4% of the economy to 10% within a two-decade span -- and partly on fiction -- that technology can keep climbing in perpetuity, to 20% of the economy.
The dividend from Microsoft is a positive sign, but it is also another reminder that technology is a sector like any other, and one where real cash payouts are worth a dozen promises of future growth. It's hard to believe anyone still needs to be reminded after three years in the bear's grip that technology is just as vulnerable to the reality of the market as energy was in the early 1980s and the Nifty Fifty stocks were in the early 1970s. However, the recent run-up of some tech stocks during the fourth quarter suggests some people haven't learned.
5. A Starter Dividend
Microsoft's 16-cent dividend doesn't add up to much -- about 0.3%. That doesn't look like much next to the 1.71% yield offered by the average
company, noted James Altucher,
columnist and partner at hedge fund Subway Capital.
However, Microsoft CFO John Connors made a point of calling it a "starter dividend." The implication is clear: It will raise the dividend down the road.
"The key with dividends is dividend growth; it's not high yields," says Acuff. "You want companies that generate lots of cash in excess of their needs. There aren't too many out there --
Johnson & Johnson
. Microsoft is one of them."
6. A New Breed of Investors
It seemed like just about every money manager in the country in the 1990s owned Microsoft. However, not all of them did -- in fact, scores of institutions such as pension funds and many equity-income funds were not allowed to own Microsoft because their mandates require that they own only dividend-paying stocks.
Now, they can. Microsoft will most likely benefit in two ways: First, the company is fair game for a new breed of institutional investors; second, this breed tends to include less-active traders, meaning Microsoft's stock may be a bit less volatile.
But there's another investor class that Microsoft appears to be courting: the individual. President Bush's proposal to eliminate the double taxation of dividends is geared toward helping investors, but it primarily helps people who invest directly in stocks and funds outside of their tax-deferred retirement accounts. Some market pundits have speculated that this may lead investors to put more money to work directly in stocks. Microsoft certainly made itself more desirable to individuals with its dividend.
An eye on individual investors may help to explain another move: the company's stock split. In tandem with the dividend news came Microsoft's announcement that it would split its stock. This left some on Wall Street scratching their heads, since the stock was trading in the mid-$50s at the time -- hardly the triple-digit price tag that tends to scare away individual investors. The 2-to-1 split put Microsoft shares in the high $20 range -- making it a lot easier for individuals to purchase, say, a 100-share lot of Microsoft.
7. The Other Shoes
Make no mistake, Microsoft's dividend doesn't mean investors should run out and buy up technology stocks because a dividend bonanza is coming. First off, to offer a dividend, you need to have two things -- cash and profits. Microsoft has $43 billion in cash and is profitable.
"Very few have as big a cash hoard as Microsoft has," Wharton's Siegel says. "In this difficult time, most tech companies are barely earning money."
However, Siegel and others expect that when the technology outlook and the economy finally turn up, a large number of technology companies will either initiate a dividend or increase their existing ones.
Now that Microsoft has bitten the bullet, all eyes are on
(which is considering a dividend) and
already offers a 0.47% dividend; investors are hoping for an increase.)
Cisco, with $21 billion in cash, has given no indication that it will pay a dividend, but Microsoft's move heightens the pressure. While the network equipment company has suffered in the IT-spending drought, Altucher thinks Cisco is well-positioned to post huge profits during the next spending uptick. He also thinks it will eventually offer a dividend -- but not until the peak of the next cycle.