When you are investing for some time, then you know that some of the stocks in your portfolio just continue to grow their share price.
Those companies are typically experiencing a large tailwind fueled by one or more secular growth trends. Hence, it feels like nothing can stop their momentum.
And if you own such stock, then it might even feel like winning the lottery, because most of us were unable to predict such stellar growth at the time of buying.
But there is also a downside to that because holding such a stock is not always easy for a dividend growth investor.
As an example, the dividend yield might drastically decline if the share price doubles in a short period of time.
In such a situation, it is quite natural to start thinking about selling the stock, taking some profits, and reallocating the money into a better-yielding dividend stock. You can give a nice boost to your dividend income by doing this.
More passive income is what we like, right?
But is this really the right thing to do in our pursuit of financial independence?
As always, my personal answer is: it depends.
If you are very close to (early) retirement and you need the dividend income now, then maybe this could be a good idea.
If the position size became way too large (i.e.: >15%) and the stock feels very overvalued to you, then maybe this might also be a good idea. Reducing risk in your portfolio to protect your principal is very important. Just watch out to not replace it for a yield-sucker.
In most other cases, I would definitely consider keeping the stock and letting the compounding do its work.
Let’s take as an example the title of this blog as a reference.
According to court filings, Microsoft CEO Satya Nadella told fellow executives in 2022 that they aim to reach $500 billion in revenue by the 2030 fiscal year.
The company made 198 billion in revenue in 2022 so they are aiming to more than double that number.
It also suggests a compounded annual growth rate of ~ 12.5% in revenue which is very strong for a company their size.
Let’s do even some more math.
Their net income margin has been around 31% over the last few years. I expect this to slightly increase over time due to their cloud business, but let’s assume that it stays the same in our base case.
In such a case, we are talking about 155 billion dollar profit in a single year.
This translates into a 20.5 EPS in 2030 when not taking any buybacks into account (2022 EPS was 9.65). Based on today’s share price, this would mean a 17.5 Price to Earnings multiple.
However, share buybacks do matter, because they have reduced Microsofts share count by an average of 0,9% over the last 5 years. Hence, let’s consider this aspect in our math as well.
As you can see in the above table, it increases the EPS number to 22.45. This would mean a ~16 Price to Earnings multiple.
This then begs the question: what is a reasonable earnings multiple for a company that grows its revenue by 12.5% annually? Today, the PE multiple for Microsoft is 39 and I find this a bit rich.
However, a 30-Multiple is something I can definitely foresee during a normal market where prospects for the growth of the underlying business remain the same.
In that case, you may expect Microsoft to trade at 675 dollars per share. This would still give you a ~9.4% compounded annual growth rate in the share price ( formula: (675/359)^(1/7)-1) ).
Honestly, I take this any time, because these are still good growth numbers and we are talking here about a super high-quality company.
And on top of that, I would still expect the dividend to grow with double-digit numbers over the next 7 years. This means that my dividend income from my Microsoft holding should double and bring my yield-on-cost to 10+%.
Still a very decent deal, wouldn’t you agree?
Having said all of this, everything depends of course on the execution of Microsoft and their ability to hit those numbers. If you don’t feel comfortable about that, then indeed, trimming or selling might be a good idea.
However, I believe that Microsoft can pull this off. They have the best Tech CEO in the world and their flywheel is spinning in all kinds of directions.
Whether it’s their Cloud business, Artificial Intelligence, Office Suite, Gaming, or Social Networking. At this moment in time, they are a driving force to be reckoned with almost everywhere.
This results in money just splashing at their doorsteps while they already have one of the strongest balance sheets in the world.
I’m genuinely happy for Satya Nadella that he’s living in the digital age. Just imagine what it would be like if he and his team would need to process all that physical money themselves.
To conclude, the above Microsoft case is a very clear example to me to explain why I prefer to always let my winners run.
Yes, I love dividends, but in the end, I’m a dividend growth investor.
If a business is firing on all cylinders and growth is just everywhere, then I’m very confident that high dividend growth will be a result.
And that’s my ultimate goal:
Own many high-quality businesses that can safely grow their dividends for years to come.
I hope you enjoyed this short opinion piece. I know that these kinds of topics are in many people’s minds nowadays. Especially during the recent market rally which we are experiencing this summer.
European Dividend Growth Investor
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