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Cisco Systems (CSCO) is an old tech company that is still the global leader in networking hardware and software. Essentially, Cisco sells the nuts and bolts that makes the internet work. This is a very profitable business, but it is slow growth now. Growth stocks in the tech space are now mostly focused on cloud and AI. That said, Cisco is highly profitable and generates an impressive amount of cash flow annually. The high cash flow has been used for bolt-on acquisitions, share buybacks, and more importantly a growing dividend. The current yield is roughly 3.5% and the dividend is safe. The company struggled during the initial stages of the coronavirus pandemic, but recently reported decent earnings results beating estimates. Dividend growth investors should take a look here since market sentiment is still largely negative for Cisco and the valuation is relatively low.

Overview of Cisco

Cisco is world’s largest Internet Protocol networking company. The company was founded in 1984 by Leonard Bosack and Sandy Lerner. The company operates in three business segments: Infrastructure Platforms Group, Security Segment, and Services. The company sells hardware, software, and services for switching, routing, data centers, and wireless applications. Cisco also sells software and services for networking, analytics, collaboration, and security, and firewalls. Major brands or products include Catalyst, Nexus, WebEx, Duo, and Aironet. Cisco had $49,301 million of revenue in 2019.

Cisco Dividend Growth and Safety

Cisco is a dividend growth stock, but the company is still relatively new as a dividend payer. The regular quarterly cash dividend was initiated in 2011 at $0.06 per share. It has grown rapidly since then and the regular quarterly cash dividend is now $0.36 per share. This is nine consecutive years of dividend growth making Cisco a Dividend Challenger. The trailing 5-year growth rate is about 13.3% (CAGR). However, growth is slowing as the payout ratio has risen. The annual growth rate of the dividend was only 3.6% in the past 1-year. Despite the slowing growth rate, the current payout ratio is still less than 50% providing room for further increases.

Today, Cisco pays an annual forward dividend of $1.44 and is yielding approximately 3.5%. The current yield is more than double the average yield offered by the S&P 500 index of about 1.7% making Cisco an income stock in comparison.

Cisco’s trailing dividend safety metrics are excellent. In fiscal 2020, the payout ratio was approximately 54%. The forward payout ratio based on consensus fiscal 2021 earnings is lower at about 46%. The dividend was also well covered by free cash flow. In fiscal 2020, operating cash flow was $15,426 million and capital expenditures were $770 million giving a free cash flow of $14,656 million. The dividend required $6,016 million giving a dividend-to-FCF ratio of 41%.

Debt is not an issue from the perspective of the dividend as Cisco has a net cash position of $15,466 at end of Q1 FY2021. Importantly total debt has declined over the past few years. The current portion of long-term debt is about $5,002 million and long-term debt is approximately $9,564 million. Total debt is $14,566 million down from a peak of almost most $35 billion in early 2017. This reduction in debt is impressive and is due to Cisco’s high cash flow. Current debt is offset by a little over $30 billion in cash and short-term investments. Clearly, debt does not place the dividend at risk.

Risks for Cisco

The major risk for Cisco is that it is in very competitive end markets. In the infrastructure market there several other major players with the scale to compete effectively in hardware. This includes Arista Network (ANET), Juniper Networks (JNPR), Aruba Networks, and Huawei. Other companies compete with Cisco in the area of software and security including Palo Alto Networks (PANW), Checkpoint Technologies (CHKP), Fortinet (FTNT), F5 Networks (FFIV), and FireEye (FEYE). This competition requires Cisco to continually invest in hardware and software. Cisco is also a serial acquirer of smaller companies with new technology. No other single company has the scale and breadth of Cisco. The company has positioned itself as a vendor of complete solutions for enterprise networking.

Final Thoughts on Cisco

Cisco’s major competitive advantages are its scale and long-term relationships with enterprises. Most businesses don’t want to risk disrupting their internet service, and this provides a moat. Cisco also has a fortress balance sheet, and this supports the dividend and the bolt on acquisition strategy. Cisco is now trading at a reasonable valuation of about 13.2X consensus earnings. For comparison, the S&P 500 is trading at over 30X at this juncture. In an arguably overvalued market, Cisco offers income and dividend growth at a reasonable valuation.