Does Cisco Systems Belong in a Dividend Stock Portfolio?

The Nasdaq Composite crossed 5,000 this year, reaching that threshold for the first time in 15 years. It’s been a long road, but investors in the index can finally put the dot-com boom and bust behind them.

But not all of the high flyers from the late 1990s have regained their former glory. It’s hard to believe now, but Cisco Systems, Inc. (CSCO) was one the most valuable company in the world. Today, it doesn’t rank in the top 50.

And while Cisco stock has been rallying for the past four years, more than doubling since bottoming out in mid-2011, the price of Cisco still is 65% below its old bubble high.

Cisco Systems stopped exciting momentum investors a long time ago, and CSCO probably will never again be a growth dynamo. Its routers and switches have become commoditized products and face increasing pressure from cheaper software-based alternatives. But this slower-growing, more-mature Cisco stock is starting to get attention from a different corner of the market: Dividend hunters.

Cisco Stock: A Friendly Face for Income Investors

Cisco declared and paid its first quarterly dividend in 2011, at 6 cents per share, and has since become a dividend-raising machine. This quarter, Cisco raised its dividend for the fifth time in four years, to 21 cents per share. That’s a 250% increase in just four years.

chart4 CSCO: Does Cisco Systems Belong in a Dividend Stock Portfolio?

Let’s play with the numbers a little here. Cisco’s annual dividend of 84 cents works out to a current dividend yield of 3%. Had you bought shares of Cisco stock just before its first dividend in 2011 and held on to it until today, your yield on cost would be just shy of 5%. (For those unfamiliar with the term, “yield on cost” is the current annual dividend divided by the original purchase price. It’s a useful metric for long-term dividend investors investing primarily for income.)

Seen by itself, Cisco’s 3% dividend is not wildly compelling. Yes, it is significantly better than the 10-year Treasury yield and the dividend yield on the S&P 500, both of which offer about 1.9% these days. But it is also significantly below the level of many REITs, MLPs oil majors and other higher-yielding corners of the market. So, if you’re buying Cisco stock for its dividend, you had better be confident that its high rate of dividend growth will continue.

Well, we may not see 250% growth every four years going forward, but I do expect Cisco to be one of the biggest raisers among its large-cap peers.

When Cisco decided to pay its first dividend, it essentially made a new pact with shareholders. Henceforth, Cisco would be committed to rewarding its patient shareholders with dividends equal to at least 50% of its annual free cash flow.

On this count, Cisco stock actually has a little catching up to do. Over the trailing 12 months, its free cash flow has totaled $2.12 per share. That puts its current dividend at about 40% of free cash flow. Another popular metric for dividend sustainability, the dividend payout ratio, also indicates Cisco has a little wiggle room to keep raising its dividend. Cisco’s current dividend payout ratio is a very reasonable 45%.

Of course, ultimately Cisco’s ability to keep raising its dividend will hinge on its ability to grow its earnings. And on this count, Cisco’s prospects aren’t looking bad. Last quarter, Cisco beat analyst earnings estimates and offered upbeat guidance going forward. Even in a more competitive environment, Cisco has managed to double its revenues over the past decade.

Bottom Line

Cisco’s competitive pressures will not be going away overnight, and Cisco will probably see continued margin erosion for the foreseeable future.  I should emphasize again that this is not a high-growth company. But Cisco stock would make a nice addition to a diversified dividend stock portfolio.

Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.

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