Microsoft (NASDAQ:MSFT) stock has been in a slump recently but it has still done well over the past year. MSFT stock will continue moving higher over the next year as its free cash flow (FCF) and dividends push it higher.
In the past year, MSFT stock has risen more than 45% and is up just over 28% year-to-date. In fact, in the last six months, the stock has risen more than 47%. This is despite the fact that the stock has fallen 10.5% to around $204 as of Sept. 24.
But Microsoft continues to grow. Earnings per share (EPS) is forecast to be 12% higher for the June 2021 fiscal year. Moreover, 27 analysts polled by Seeking Alpha estimate June 2022 EPS will be $7.33 per share.
This is 13.6% over the $6.45 forecast for the June 2021 forecast year. Similar estimates at Yahoo Finance from their analyst polls underline the company’s growth prospects.
This leads to expectations that the dividend will rise over the next year.
Dividend Expectations at Microsoft
Microsoft has been paying a dividend since 2003. Its dividend has been growing consistently since then. In fact, last week the company just declared another increase (+9.8%) in its quarterly dividend.
In the past five years, Microsoft’s dividend has grown from 36 cents per share to 56 cents per share recently. You can see this in the chart at the right.
That 55.55% increase over five years represents a compound annual growth rate of 9.23% annually. That is a very high growth rate.
Meanwhile, EPS has grown from $2.56 to $6.45 (June 2021 forecast) during that same period or a gain of 252%. That works out to 20.3% per year on a compound growth rate basis.
In other words, earnings growth is over twice as fast as dividend growth. So there is plenty of room for the company to pick up dividend growth.
FCF Growth Propels Its Value
Free cash flow in the past year has been amazing. You wouldn’t have known that there was a global pandemic.
You can see this growth in the chart on the right. It shows that FCF in the last 12 months (LTM) viewed each quarter has consistently moved higher.
For example, free cash flow, which is equal to cash flow from operations less capex spending, for the year ending June 2019 was $38.26 billion.
But cut to a year later, the LTM FCF for June 2020 was $45.2 billion. That represents growth of more than 18.1% in the past year.
You can see that one reason for this was that free cash flow was a higher percentage of sales in the LTM to June 2020. The FCF margin was 31.6% over the prior year. But a year ago its LTM FCF margin was 30.4%.
But the reality is this is a huge percentage of sales. Many other companies do not make anywhere near this kind of FCF margin. In fact, most companies would be lucky to make one-third of that level of free cash flow.
Another reason that free cash flow is growing is simply that revenue growth is significant. You can see in the chart above that LTM revenue in the past year has grown from $125.8 billion to more than $143 billion.
That represents a growth rate of 13.7%. This is a big portion of the 18% growth in FCF over the last year.
Where MSFT Stock Is Going Next
Microsoft has a huge cash balance of $136.5 billion. It uses some of that money on acquisitions from time to time. But most of its FCF is used to both pay dividends and also repurchase shares.
I have written numerous articles in the past on why share buybacks enhance the value of a company. But one thing I want to emphasize here is that Microsoft’s free cash flow is the source. That is what drives its dividends, buybacks, acquisitions and cash accumulation.
I expect that there is every reason that Microsoft’s FCF growth will continue to grow very strongly. This will continue to propel the stock higher each year as long as FCF continues its stellar growth.
If its FCF continues to grow 18.1% annually over the next three years, this works out to compound growth of 64.7%. Assuming a 10% discount rate for the present value that would mean Microsoft is worth 75.1% of that 64.7% higher price.
That works out to a 49% higher stock price. In other words, MSFT is worth $308.99 per share.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.