- Cisco has compelling valuation and high growth prospects.
- Cisco is paying a generous dividend, yielding about 3.2%.
- Cisco stock is a smart long-term investment right now.
In my view, Cisco (NASDAQ:CSCO) stock should be included in every diversified large cap dividend stocks portfolio, and now is the right time to buy the stock. While waiting for an improvement in the global environment, investors can enjoy the generous dividend, yielding 3.16% a year. Despite currency impact and the challenging macro environment, Cisco raised its dividend by 24% on February 10. The company also announced that it would add $15 billion to its stock buyback program. The significant dividend and buyback increase demonstrates the company's confidence in the sustainability of its free cash flows. What's more, CFO Kelly Kramer said that Cisco remains committed to its shareholders in delivering profitable growth and returning a minimum of 50% of its free cash flow back to them annually.
Cisco's Strong Earnings Track Record
On February 10, Cisco reported strong results for its second-quarter fiscal 2016, which beat EPS expectations by $0.03 (5.6%). Revenue of $11.93 billion in the period also was better than the average Street forecast for revenue of $11.76 billion. In addition, Cisco forecast that profit before certain costs in the current quarter will be $0.54 to $0.56 a share and revenue will rise 1% to 4%, indicating sales of $12 billion to $12.4 billion. That compares with average analyst projections for a profit of $0.55 a share on $12 billion in sales. Cisco has delivered earnings per share surprises in all its last ten quarters, as shown in the table below.
Cisco's Profitability Is Improving
In my view, the fact that Cisco has been able to increase its gross margins despite the challenging macro environment is very encouraging. According to the company, it has experienced one of the most volatile times in global markets. This volatility has led to a slowdown in spending, impacting its business, especially during the last few weeks of January as it closed its quarter. Despite this slowdown, Cisco executed very well, with total revenue growth of 2% and non-GAAP EPS growth of 8%, strong margins, and operating cash flows up 36%. Cisco's ability to deliver strong profitability in a challenging environment reflects the operating leverage it has created in its business over the last several years. What impressed me more is that at a time when many technology companies are reporting declining earnings and margins, Cisco has shown improving results. The recent quarter's gross margin of 63.8% was the highest in the past ten quarters, as shown in the chart below, which also demonstrates the uptrend in gross margins in the last three quarters.
Source: Company's reports
'Americas', Cisco's primary segment, accounted for about 60% of revenues in the second quarter. Americas' gross margin in the recent quarter was also at 63.8%, the second highest in the last ten quarters, as shown in the chart below, which also demonstrates a similar uptrend in gross margins in the last three quarters for the 'Americas'.
Source: Company's reports
Cisco Growth Prospects
I see strong growth prospects for Cisco, both organic and through acquisitions. Cisco has a history of using weak market phases to buy niche assets at a discount. During the second quarter, Cisco acquired Portcullis (security), ParStream (data analytics), and Lancope (video). Since the end of the quarter, Cisco acquired Acano (collaboration & video) and announced the $1.3 billion acquisition of Jasper (cloud-based IoT SaaS), which should close during the third quarter of fiscal 2016. According to the company, the acquisition of Jasper, combined with its other capabilities, will enable Cisco's customers to monetize the data from billions of sensors and connections with the security, speed, and reliability they have come to expect from Cisco. Cisco's momentum reflects the uniqueness of its business model and its ability to weather volatility while accelerating innovation in key markets to drive long-term growth. Cisco said that it is growing its cloud-based SaaS business at double-digit rates, in products including WebEx, Meraki Cloud Networking, and Security. The company estimates that the IoT market will be valued at $19 trillion in the next ten years, including $1.7 trillion in service providers.
Since the beginning of the year, Cisco's stock is down 2.2% while the S&P 500 Index has declined by 6.2%, and the Nasdaq Composite Index has lost 10%. Since the beginning of 2012, Cisco's stock has gained 46.8%, in this period, the S&P 500 Index has increased 52.5%, and the Nasdaq Composite Index has risen 72.9%. According to TipRanks, the average target price of the top analysts is at $29.79, 12.2% higher from its February 19 close price, however, in my opinion, Cisco shares could go much higher.
Cisco's valuation metrics are excellent. The trailing 12 months P/E is low at 13.14, and the forward P/E is even lower at 11.11. The quick ratio is extremely high at 3.20, and its price to cash ratio is exceptionally low at 2.23. Furthermore, its Enterprise Value/EBITDA ratio is very low at 6.81.
In addition, Cisco's Margins and Return on Capital parameters have been much better than its industry median, its sector median and the S&P 500 median as shown in the tables below.
Cisco Buybacks And Dividends
For the second quarter of fiscal 2016, Cisco repurchased approximately 48 million shares of common stock under its stock repurchase program at an average price of $26.12 per share for an aggregate repurchase amount of $1.3 billion.
Cisco has been paying uninterrupted dividends since 2011. The annual dividend yield is pretty high at 3.16%, and the payout ratio is at 41.2%. The annual rate of dividend growth over the past three years was very high at 41.9%.
To summarize, considering Cisco's compelling valuations, its high growth prospects, and the generous dividend, Cisco stock is a smart long-term investment. The average target price of the top analysts is at $29.79, up 12.2% from its February 19 close price, however, in my opinion, shares could go much higher.