Nobody Told Cisco it’s No Longer a Growth Stock
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While many analysts have interpreted the 75% increase to Cisco Systems’s (NASDAQ: CSCO) dividend as an admission by management that the company is no longer a growth player, unfortunately nobody bothered to tell them.
There is no doubt that the company’s stated intention to return as much as 50% of its free cash flow (FCF) to shareholders is a response to investor needs. The recent announcement of its deepening strategic partnership with VMware (NYSE: VMW), however, is not the action of a stale and stodgy value player. Cisco seems to be both on the brink of the development of a major new business segment and simultaneously maintaining its dominance in more seasoned business lines. The combination of these factors encourages a fresh look at the company through a less jaded lens.
The Old Line Opportunity
While Cisco’s numbers at its most recent earnings report were mixed, the addition of the dividend is significant for investors. As a diversified player in a variety of areas, Cisco is exposed to significant growth prospects within its existing core businesses. The wireless network space, for example, continues to show strength. Cisco competitor Aruba Networks (NASDAQ: ARUN) recently announced strong earnings results that were largely attributed to the space. Aruba was able to grow revenues by 22% and create EPS growth of 6%, both better than consensus estimates. Guidance was in line with expectations, but underlines the continuing strength in the space.
Under current guidance, Cisco expects year-over-year earnings growth of 2 to 5% to translate to a 10 to 15% rise in year-over-year EPS growth. The added incentive of a dividend yield in the neighborhood of 3% is just that: an added bonus, not a consolation prize. When the addition of the income element is considered, even if the company were to rest briefly upon its laurels, it would be attractive at current levels.
The Way Forward
In a recent announcement, Cisco and VMware announced the intention to expand the strategic partnership that is already in place between the two companies. The primary purpose of the move is to begin creating an integrated division across each entity with the end goal of delivering a software-defined datacenter. Under the plan, each company will invest in the creation of a dedicated engineering team whose sole function will be the combination of VM’s cloud computing initiatives with Cisco’s advanced data networking capabilities. Collaboration of this kind is extremely rare, particularly in the fast paced world of growth technology.
The overarching concept of the project is the complete integration of the virtual and physical computing needs of the companies’ customers. Some of the stated targets include: agility in computing and networking, mobility for workspace and workload management, streamlined troubleshooting and end-to-end visibility. The list and technical targets of the venture are comprehensive and have the potential to significantly redefine the space.
Pat Gelsinger, the incoming CEO of VMware, is quoted in the article referenced above as stating:
The software-defined datacenter will deliver the next leap in software-based datacenter automation across server, storage and networking, but it requires equal hardware and systems-based innovation. We are very excited to further our partnership with Cisco, the industry-leading innovator in networking, as we believe it will bring significant value to our joint customers through the integration of the VMware cloud infrastructure platform with Cisco's intelligent network fabric.
The insights of the two companies have the potential to combine in a unified product offering that should become the new standard in the industry. As data and network management continue to swell in importance, both as matters of financial and social impact, the software-defined datacenter may provide long-needed solutions for customers.
If that’s Not Growth Potential…
There can be no question that Cisco has reached maturity in a variety of product areas, and it may be argued that its slowness to react has caused lagging returns during certain periods. Considered against the global economic slowdown that has been marked by decreased spending by business, the company has done well. Now that it offers an income element, the stock is a near must-have in one’s core portfolio. The fact that Cisco is continuing to push the innovation envelope means that it can equally make one’s growth portfolio. What the company’s detractors should realize is that in either column, the stock looks great.
Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of VMware. Motley Fool newsletter services recommend VMware. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.