Has This Tech Giant Become A Dividend Stock?
Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The timeline of big tech companies seems to be consistent. First, a period of extremely high growth. Second, a period of declining growth. And third, an acceptance of slower growth and a renewed focus on returning profits to the shareholders. More and more tech companies are beginning to increase dividends and buybacks and return significant cash flow to shareholders. One of these companies is Cisco (NASDAQ: CSCO).
In March of 2011 Cisco announced the first dividend in its history. The quarterly dividend was set at $0.06 per share per quarter, an annual dividend of $0.24 and a yield of 1.4% based on the stock price at the time. Rank Calderoni, Chief Financial Officer, stated:
As the role of the network expands across the IT sector, Cisco's leadership position in the markets we serve is strong, and the time is right for Cisco to pay our first-ever cash dividend.
It didn't take long for the company to increase the dividend again. In February of 2012 Cisco announced a quarterly dividend of $0.08 per share, a 33% increase from the initial dividend. Then, in August of 2012, the dividend was increased to $0.14 per share per quarter, a 75% increase. This $0.56 annual dividend represents a 3.04% yield on the current share price of $18.41.
In fiscal year 2012, which ended in July, Cisco recorded $10.365 billion in free cash flow. The current dividend payment of $0.56 per share on 5.405 billion diluted shares outstanding means a total dividend payment of $3.026 billion. The payout ratio, which I define as total dividends paid divided by free cash flow, is just 29.2%. This is extremely low and gives the company a lot of room to grow the dividend.
In addition to the ample cash flow, Cisco has a fortress balance sheet. The most recent balance sheet shows about $48 billion in cash compared to $16 billion in debt, leaving $32 billion in net cash. The problem is that most of this cash is overseas and thus cannot be paid out as dividends without paying significant taxes. Luckily, Cisco's cash flow can easily handle the dividend.
Although Cisco is dominant in its core businesses, the company does face competition. Juniper Networks (NYSE: JNPR) commands around a 27% market share in the core router market, compared to about 55% for Cisco. In the ethernet switch market, Hewlett-Packard had a 10.5% market share in 2011, compared to 68% for Cisco.
How Fast Will it Grow
How fast will Cisco be able to grow the dividend in the future. It's hard to say, but a simple calculation that we can do is to determine the growth rate which justifies the current share price. I'll use the dividend discount model for this calculation, which values a stock based solely on the value of all future dividend payments. I'll use a discount rate of 8%, which is roughly the long-term growth rate of the market as a whole. For the growth model, I'll assume that the dividend grows at x% per year for the first ten years and 3% perpetually after that. The goal is to find x such that the calculation gives the current share price. If it's reasonable to believe that the dividend will grow faster than this value, then the stock is undervalued.
Using the above parameters the 10-year dividend growth rate necessary to justify the current share price is 8.9%.
The Bottom Line
With a payout ratio of only 30% and a commitment to returning profits to shareholders, Cisco looks poised to grow the dividend significantly over time. According to my dividend discount model Cisco needs to grow the dividend at 8.9% per year in order for the current market price to be justified. This seems likely, and because of this Cisco makes a great addition to a dividend focused portfolio.
TheBargainBin owns shares of Cisco. The Motley Fool has no positions in the stocks mentioned above. 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.