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Cisco is the global market leader in enterprise networking hardware and software. It is a popular dividend growth stock, having attained Dividend Contender status. It is also a Dow Jones Industrial Average company.

The dividend yield was 3%+ at the start of the year, placing it on the current Dogs of the Dow list. The stock price is up this year, and the yield is down. However, at the proper valuation, we view Cisco (CSCO) as a long-term buy because of its dividend safety and market dominance.

Overview of Cisco

Cisco Systems was founded in 1984, and it has grown into the world’s largest Internet Protocol networking company. Today, the company sells enterprise hardware and software for networking, switching, routing, data centers, and wireless applications. Additionally, Cisco sells software for networking, analytics, collaboration, and security and firewalls. Cisco is ranked 15^th in the 2022 Interbrand’s Best Global Brand list. 

Cisco reports two business segments: Products and Services. But it also lists similar products and services categorized as Secure, Agile Networks, Internet for the Future, Collaboration, End-to-End Security, Optimized Application Experiences, Other Products, and Services.

Total revenue was $56.988 million in fiscal 2023 and the last twelve months. 

Revenue and Earnings Growth

Cisco’s revenue growth has slowed considerably from its early years because IP networking is a mature business. In the trailing decade, the growth rate was, on average, 1.6% annually. The firm sells both products and subscriptions. The shift to a software-based subscription model started in about 2015, resulting in deferred revenue and more money on its balance sheet as a liability.

As Cisco delivers its subscription products and services, the liability transitions to revenue on the income statement. Consequently, Cisco maintains a net cash position on its balance sheet and has better visibility of revenue and cash flow.

As the global market leader, Cisco acquires numerous companies yearly to strengthen its product offerings and maintain its number one position. Most of the M&A is small and tuck-in size. However, Cisco periodically purchases larger companies.

It recently announced a deal to buy Splunk (SPLK) for $28 billion, expanding its security offerings. However, this acquisition will only move the needle a little for revenue since the smaller firm has had sales of roughly $3.8 billion in the last twelve months.

Despite low revenue growth, earnings per share have risen dramatically because of substantial share buybacks. Cisco has lowered its share count by more than one billion shares in the past decade. As a result, EPS has increased at 6.8% on average annually.

Cisco will likely continue acting as a consolidator in the industry, allowing it to maintain its enterprise networking dominance.

Competitive Advantage and Risks

Cisco’s main competitive advantage is its brand, long-term customer relationships, hardware market dominance, and balance sheet. The company is positioned as a one-stop solution for networking requirements, which is unlike most of its peers.

The company operates in a very competitive end market and faces significant competition in hardware and software. Major hardware and software competitors include Arista Network (ANET), Juniper Networks (JNPR), Huawei, Palo Alto Networks (PANW), Checkpoint Technologies (CHKP), and Fortinet (FTNT).  

In addition, risk exists for its contract manufacturing business model for some of its products. Geopolitical conflicts and supply chain interruptions may affect sales. Also, customers often cut enterprise networking spending when economic conditions are weak.

Dividend Yield and Growth

For investors interested in income and dividend growth, Cisco pays an annual forward dividend of $1.56 per share, and the calculated dividend yield is approximately 2.93%. This solid value is much greater than the about 1.58% yield offered by the S&P 500 index. However, it is less than the five-year average of 3.01%.

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Source: Portfolio Insight

As a dividend growth stock, Cisco is a relatively new one. It initiated a dividend in 2011 and is thus a Dividend Contender. The most recent dividend hike was in February 2023. Investors can expect another increase early next calendar year.

Despite an excellent calculated payout ratio value of about 45%, the dividend growth rate slowed appreciably. It is ~11.7% in the trailing 10 years and ~6% in the past five years. However, in the past three years, the growth rate has been in the low single digits.

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Source: Portfolio Insight

Cisco Dividend Safety

Cisco’s dividend safety metrics are excellent from the perspective of earnings, free cash flow (FCF), and the balance sheet. From an earnings perspective, the dividend is safe, with a forward payout ratio of about 45%. This value is based on the forward dividend rate of $1.56 and consensus fiscal 2024 earnings per share of $4.06. Our target value is 65%, suggesting that the dividend is safe.

Moreover, the dividend is safe from the perspective of FCF. In the past twelve months, FCF was approximately $19.037 million. The dividend required $6.302 million, giving a dividend-to-FCF ratio of roughly 33%. This is below our criterion of 70% and emphasizes the view that Cisco’s dividend is safe.

Lastly, Cisco’s balance sheet is a fortress with a net cash position. At the end of fiscal year 2023, short-term debt was $1.733 million, and long-term debt was $6.658 million. However, this was more than offset by $10.123 million in cash and cash equivalents and $16.023 million in investments. Interest coverage is more than 36X. Debt is not a risk to the dividend.

Further, Cisco has an AA-/A1 high-grade and upper-medium investment credit rating, which gives more certainty about the balance sheet and dividend safety. Furthermore, Portfolio Insight’s dividend quality grade is an ‘A,’ but primarily due to inconsistent revenue growth and flat earnings growth during the COVID-19 pandemic.

Cisco’s Valuation

Cisco’s share price has risen about 11% year-to-date. However, the price-to-earnings ratio is only ~13.1X, below that of the broader market. It is reasonably valued compared to some other tech and growth stocks. Furthermore, the current P/E ratio is less than the five-year range but in the middle of the 10-year span.

A target P/E ratio of 15X gives a price target of $60.90. The Gordon Growth Model Formula provides a price target of $52, assuming an 8% return and a 5% dividend growth rate. Portfolio Insight’s blended fair value model gives $54.51. Hence, the stock is likely fairly valued to slightly undervalued at present.

Final Thoughts About Cisco Dividend Safety Analysis

Cisco has become a favorite of investors following the use of a dividend growth strategy because of its safety, growth potential, and yield. The stock is slightly undervalued based on earnings multiple, but the yield is below the five-year average. Cisco is an excellent stock to own, but a higher yield is desirable. Investors may want to wait for a slightly better entry point.

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