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Can Cisco Systems Continue Its Strong Dividend Growth?

April 12, 2014

If you're looking to buy a partial ownership stake in a publicly-traded company, then there are a number of things that you should consider before doing so. These things include the company's business model, historical earnings growth and corporate governance. Another thing that you may want to consider is the dividend.

Dividends are very important as they can provide some cushion for investors to the downside and can also signal confidence from management in the company's future. Many investors pursue dividend-paying stocks to augment their returns with a nice income stream. Most of them prefer to diversify into many different sectors of the economy in order to spread out their risk.

Today, let's take a look at Cisco Systems, a huge player in the technology sector of the economy. Let's see how the dividend of Cisco stacks up in terms of strength and sustainability and what investors can expect going forward.

Dividend Yield

The first and most obvious consideration when evaluating a company's dividend is the dividend yield, which represents the percentage of your investment that you'll receive back over the next 12 months at current share prices and dividend payouts.

Cisco currently yields 3.3%. This yield is based on its most recent quarterly payout of 19 cents per share. Cisco's dividend yield is currently at its highest point.

Dividend Growth

When analyzing a dividend, it's not all about the yield. As an income investor, you want that dividend to grow over time in order to protect your income stream from the erosive effects of inflation as well as to show confidence from management in the company's outlook.

2014 2013 2012
12% 55% 83%

Table 1: Dividend Growth Rates from Cisco Systems

Table 1 shows impressive dividend growth from Cisco over the last couple of years. However, we should also keep in mind that Cisco just started paying dividends in 2011, which should at least partly explain the astronomical growth rates in 2012 and 2013.

Free Cash Flow Payout Ratio

While high dividend yields and strong dividend growth are nice, we need to make sure that the company in question can generate enough cash flow to cover its dividend payment. The free cash flow payout ratio tells us what percentage of the company's free cash flow is eaten up by dividend payments. Lower free cash flow payout ratios are better as they leave more room available for future dividend increases or other uses of the capital.

Free cash flow is the cash flow a company generates in its operations minus capital expenditures.

TTM 2013 2012 2011
32% 28% 14% 7%

Table 2: Free Cash Flow Payout Ratios of Cisco Systems

Table 2 shows that the dividends from Cisco Systems are in very good shape, as they are currently consuming about one-third of free cash flows. This leaves the door open for strong future dividend increases along with other value-creating activities.

From looking at the company's free cash flow payout ratio, it can be concluded that the dividend is in no danger at this point in time.

Interest Coverage Ratio

One of the ways in which we can determine whether or not a company will have trouble paying its dividend in the future is by looking at how much interest it has to pay every year. More money spent on interest means less money that is left for dividends. To determine the effect that debt has on a company's ability to pay its dividends and fund other activities, I calculate the interest coverage ratio. This ratio is calculated by dividing the company's earnings before interest and taxes by its interest payments over the year. You generally like to see this ratio at or above 2. If it's below this figure, then that may signal trouble ahead for the company in question.

Fortunately, this is not a problem at all for Cisco Systems. Its earnings before interest and taxes over the past 12 months covered its interest obligations almost 19 times. At this point, debt is not having an effect at all on the company's ability to pay its dividends.

Earnings Per Share Growth Forecasts

While it's good to look at what past dividend payouts have been and how they relate to past earnings, we need to get an idea as to what future dividend payouts are going to look like. One of the ways in which we do this is by looking at analyst forecasts for earnings-per-share growth. This year, analysts expect Cisco to post a 2% drop in its earnings per share, followed by an 5.6% increase in 2015. It should be mentioned that these projections are based on non-GAAP earnings.

Conclusion

The current dividend of Cisco is well-covered by its free cash flow. This is good to know, given that the company's dividend yield is at its highest point ever. In spite of uninspiring earnings per share growth on the horizon, the company's low free cash flow payout ratio when combined with what earnings growth they do get should be enough to sustain either high single-digit or low double-digit dividend growth in the near term, depending on how much management is willing to expand its payout ratio.

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WallStreetBeerMoney.com

"Do Your Own Due Diligence, But By God, Don't Drink Away Your Equity!"

dave@wallstreetbeermoney.com