Dividend Safety Analysis: Cisco Systems, Inc. (NASDAQ:CSCO)
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Chris Hohn the founder and manager of TCI Fund Management was the star speaker at this year's London Value Investor Conference, which took place on May 19th. The investor has earned himself a reputation for being one of the world's most successful hedge fund managers over the past few decades. TCI, which stands for The Read More
This week, I will be taking a look at the dividend safety of technology giant Cisco (CSCO).
My full thesis on Cisco can be seen here, but I will focus primarily on its Dividend Safety Score in this article.
Before analyzing the company’s dividend, let’s quickly recap how Cisco makes money. After all, one of the best pieces of investing advice is to only invest in simple, easy-to-understand businesses.
Cisco has been in business for more than 30 years and is one of the biggest tech companies in the world.
The company’s products (77% of sales) and services (23%) are primarily sold to businesses to help them connect computing devices to networks or computer networks with each other.
Switches and routers are Cisco’s largest product segments and help connect communications devices and manage the flow of data between networks.
Cisco’s reach is global in nature with approximately 40% of revenue generated outside of the Americas.
Cisco’s Dividend Safety
As I noted in my recent analysis of Caterpillar’s dividend, my intention is to never own a company that reduces its dividend payment.
The three dividend portfolios in our newsletter have been successful so far. These portfolios have collectively enjoyed over 60 dividend increases and avoided any dividend cuts since they were started.
Companies usually give off a number of warning signs before they actually cut their dividends.
The companies most likely to cut their dividends usually have some combination of high payout ratios, weak free cash flow generation, declining sales and earnings, weak balance sheets, and no proven commitment to paying and growing dividends over time.
Tracking these key metrics is time-consuming, which is why I created Dividend Safety Scores to help me keep tabs on all of these factors for companies I am interested in.
Our Dividend Safety Score analyzes 25+ years of dividend data and 10+ years of fundamental data to answer the question, “Is the current dividend payment safe?”
We look at factors such as current and historical EPS and free cash flow payout ratios, debt levels, free cash flow generation, industry cyclicality, profitability trends, and more. Cisco’s most important dividend and fundamental data can be seen by clicking here.
A Dividend Safety Score of 50 is average, 75 or higher is considered excellent, and 25 or lower is considered weak.
Most companies that end up cutting their dividends score below 25 for Dividend Safety prior to announcing their dividend reduction.
Kinder Morgan, Potash, BHP Billiton, and ConocoPhillips all scored below 20 for Dividend Safety before announcing their dividend cuts.
Fortunately, dividend investors who own shares of Cisco for income can sleep well at night.
Cisco’s Dividend Safety Score of 87 indicates that the company has one of the safest dividend payments in the market.
Unlike more proven dividend growth stocks, Cisco only started paying dividends in 2011. How can the company score so well for Dividend Safety with such a limited track record?
I’m glad you asked.
Cisco’s strong Dividend Safety Score begins with its healthy payout ratios. Over the last 12 months, Cisco’s dividend has consumed 46% of reported earnings and 38% of free cash flow.
While the company’s payout ratios have meaningfully increased since Cisco began paying dividends (see below), their current level is very safe. Even if Cisco’s earnings were unexpectedly cut in half, the company’s payout ratio would still be below 100%.