We live in a technology age. You can recognize it by looking at the list of the world’s largest companies by market value. In the TOP 4, we find names such as Apple, Microsoft, Amazon, and Alphabet. As you have noticed already, all four are leaders in the technology sector. These companies shape the world of tomorrow. No doubt about it. Even though I’m not a technology freak, modern technology is exciting. It brings new opportunities and improves our lives in many spheres.
The technology sector in my portfolio is currently represented by two companies: Broadcom (AVGO) and Texas Instruments (TXN). Together they have a share of 6.9% of the total portfolio market value. In contrast, the technology exposure of the S&P500 is almost three times larger – 18.9%. While I have no intention to grow my technology exposure to that high level, I felt it was just about time to add a third technology company to this portfolio. My choice fell on Cisco Systems (CSCO).
On November 20, I have purchased 26 shares of Cisco Systems (CSCO) for a total investment of €1,064 ($1,175). Cisco Systems is a new position and the 34th company in my DGI portfolio.
Dividend Yield: 3.1% | 5-yr. Dividend Growth Rate: 14.5% | Most Recent Increase: 6.1% | FCF Payout Ratio: 40% | Consecutive Dividend Increases: 9 years
Cisco Systems is one of the strongest players in the networking world. Above all, it’s the dominant supplier of switches, routers, firewalls, and complementary networking products. In addition to it, CSCO is promoting software, analytics, wireless, and security offerings to meet emerging trends. With its extensive product portfolio, Cisco is the only one-stop-shop networking vendor. In other words, if you plan to build a networking infrastructure, this company will provide you with everything you require to succeed.
Performance & Quality
Before investing in a company, I always review some crucial performance figures. First and foremost, there are earnings and revenues. Secondly, I look at the cash flow and check how well it covers the dividend payment. And last but not least, I use some quality gauges to come up with a picture of the general quality of a business.
Most recently, Cisco did a good job by reporting solid earnings and revenue results. The Q1 figures included a revenue growth of 2% and non-GAAP EPS rose by 12%. According to Chuck Robbins (CEO), it was a “solid quarter against a challenging macro environment”. By the way, Cisco had a decent series of beating earnings and revenue expectations recently. (see picture below). It is self-explanatory that I like to see a company performing better than expected. The market is going to adjust those valuations higher due to the earnings, revenue, and cash flow increases.
Another important piece of information when reviewing earnings calls is the forward-looking guidance. If a company reports better than expected results and then comes out and shows that they expect to do even better next quarter, this will be a very attractive combination to me. Unfortunately, Cisco provided a disappointing guidance for Q2. In the next quarter, CSCO expects revenue to drop 3-5% and EPS to come in at $0.75-$0.77 (VS. consensus for $0.79). Despite the decent Q1 results, this light guidance was the major reason for the price drop lately.
The long-view earnings performance is nothing we can complain about. Over the course of the past 15 years, Cisco has experienced only one period with declining EPS. As you can guess, it was the year of the financial crises (2009: -13%). Looking at the past five years, Cisco has increased its earnings per share from $2.06 in 2014 to $3.10 in 2019. This is a CAGR of 8.52%. Beyond that, the EPS trend is remarkable. Starting from 2009 until today, Cisco has managed to grow the EPS each and every year. Even though the EPS growth is expected to be slightly lower in the future (5%), I like the overall earnings picture provided by this company.
Cisco increased its revenue from $47.14 billion in FY 2014 to $51.90 billion in FY 2019. That’s a compound annual growth rate of 1.94%. Truly nothing to be excited about. However, we should consider that CSCO is rather a mature business in the networking industry. It wouldn’t be fair to compare its growth prospects with companies from the fast-growing technology sector such as Google or Amazon.
Free Cash Flow
As dividends are a cash outflow in the financial activities section, I’m particularly interested to see the Free Cash Flow numbers. Plotting the dividends next to FCF helps me to evaluate how easily a company can cover its dividend payments. In 2019, the FCF was sitting at $14.92 billion, while cash dividends paid amounted to $5.98 billion. By interrelating both figures to each other, we get a quite low FCF Payout Ratio of 40%. So there is plenty of room for Cisco to keep growing the dividends in the future.
Many dividend growth investors seek the highest-quality companies. However, it is not always easy to come up with a uniform definition of what quality means. This is where independent data providers such as Morningstar, S&P or Simply Safe Dividends can help to evaluate the quality picture of a business.
In the case of Cisco, this picture looks very solid. SSD grades Cisco’s dividend as very safe (extremely unlikely to be cut) and Value Line rewards this networking giant with the best possible ratings for safety and financial strength. All in all, Cisco really shines bright in the quality department.
Nevertheless, an investment in Cisco isn’t free of risks and uncertainties. One major risk that comes with an investment in this company is linked to the transmission of computer workload to the cloud. For Cisco, it means selling fewer data center hardware to its clients. To protect against the losses from data centers, Cisco is rebounding to implement more software and services to its product portfolio. Software and services were 43% of fiscal 2017 revenue, and the company’s goal is to increase this share to 50% by 2020. However, it won’t be the easiest thing to compete against dominant players such as Amazon or Google in this field.
Cisco is the world’s largest hardware and software supplier within the networking solutions sector. It has a good history of earnings growth and plenty of available free cash flow to continue rewarding its shareholders with a growing dividend. To positions itself for the future, Cisco is shifting towards selling more software and services. This transition is still taking place and isn’t free of risk. However, this shift also brings the opportunity to boost revenue by focusing on recurring sales (f.e. subscriptions). I’m going to follow along with Cisco’s journey and believe that this company is well-positioned to remain an industry leader in the long term.