Buy Cisco: When Did “Dividend” Become A Dirty Word?
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As we march closer the Cisco Systems (NASDAQ: CSCO) ex-dividend date on October 2, an increasing number of sources are raising alarms over what the payout symbolizes. In fact, recently both Bloomberg and Barron’s each released articles warning that positive dividend activity for a technology stock is a sign that it is time to find the nearest exit. While each quietly acknowledge that Apple (NASDAQ: AAPL) bucks this trend – and one includes Cisco as an exception that makes the rule – the message is unmistakable. Contrary to these arguments, Cisco continues to shows signs of growth, value and sufficient attractiveness that it remains a buy and a key core holding.
The Anti-Dividend Movement
There are two pieces to the argument against dividend activity in technology stocks: one that is quantitative and one that is qualitative. To address the hard numbers first, the Bloomberg articles points out that according to its data, “[t]echnology companies that started or raised dividends in 2012 have climbed 1.3 percent on average since the announcement, compared with gains of 15 percent for those that didn’t increase payouts.” While not wanting to malign the reputation of a company for which I have great respect, without further hard data, this is a completely meaningless conclusion.
What does “average” mean? What qualifies as a “technology” company? If the average gains are calculated using simple averages, meaning every company is weighted equally, then a microcap company that exploded this year would have a profound impact on the average, but not really the market. If the companies are market cap weighted, then larger companies that are less likely to experience explosive growth will be given more influence, but are also more likely to make the dividend group as opposed to the non-dividend group. The question of which companies are counted as technology companies opens the same sort of challenges.
The qualitative argument is somewhat harder to pin down, but equally lacking in real merit. The simple version of this story is that when these companies were in full growth mode, they would spend every cent of earnings on growing and developing new products. The choice to pay a dividend has been characterized as being caused by CEOs who cannot find anything better to spend the money on than investors. The flaw in this logic is that it assumes that earlier spending by the company went to resources that have been fully exhausted. In reality, once a fabrication plant is built, if it was forward-looking, the marginal cost of increasing output is small. The company may continue to grow sales, while maintaining costs, and thus generating cash.
Rather than disparaging these business leaders, they ought to be applauded. Not only have they stewarded their companies to enviable positions, but they have recognized the reality of the economy in which they are operating. Under a climate of zero yield, a dividend is attractive to investors. One of the jobs of the CEO is to protect share price because it allows the company to maintain a strong position in the industry, with creditors and with peers. Recognizing this truth is the sign of a great leader, not one without vision.
The Chief Targets
While it is Microsoft (NASDAQ: MSFT) and Dell (NASDAQ: DELL) that are the primary targets of these critics, not Apple and Cisco, the argument stays the same. While Microsoft may have become stagnant over the past decade, the company has clearly recognized some of this stagnation and is seeking to address it. I fully expect the Microsoft Surface, the new tablet being released in October, to have a profound impact on the market. With that change, investors should look to Dell to follow this lead and produce the next generation of tablets – those used to produce, not just consume.
Each of these companies has entered a consolidation phase over the last several years. They have each faced challenges in the growth arena, but this has been a function of technology, not complaisance. The argument that the higher dividends offered by these companies is an indicator that things have gotten weak is coincidental, not a case of cause and effect. Apple has found new technology, shown phenomenal growth and paid a nice dividend. Arguments that rely on “the exception that makes the rules,” should be viewed skeptically by investors with real capital at stake.
The Cisco Growth Case
Contrary to the position of those ready to write off Cisco as a sputtering dinosaur, the company is surging ahead with great vision and appeal. The biggest sign of this is the recently announced deepening of its partnership with cloud computing powerhouse VMware (NYSE: VMW). The two companies plan to dedicate resources to the creation of an autonomous engineering team focused on the software-defined datacenter. The project combines the cloud solution of VM with the networking prowess of Cisco. The result should be an industry-changing product – a pure growth move.
Given the continuing strength of Cisco, and now the added incentive of an attractive dividend with a solid growth stock, the company is an absolute buy for your core portfolio.
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Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Microsoft, and VMware. Motley Fool newsletter services recommend Apple and 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.