Dividend paying stocks like Cisco Systems, Inc. (NASDAQ:CSCO) tend to be popular with investors, and for good reason – some research suggests a significant amount of all stock market returns come from reinvested dividends. Unfortunately, it’s common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.
With a nine-year payment history and a 3.3% yield, many investors probably find Cisco Systems intriguing. It sure looks interesting on these metrics – but there’s always more to the story . The company also bought back stock during the year, equivalent to approximately 6.8% of the company’s market capitalisation at the time. There are a few simple ways to reduce the risks of buying Cisco Systems for its dividend, and we’ll go through these below.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Cisco Systems paid out 54% of its profit as dividends. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Cisco Systems’s cash payout ratio in the last year was 40%, which suggests dividends were well covered by cash generated by the business. It’s positive to see that Cisco Systems’s dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
With a strong net cash balance, Cisco Systems investors may not have much to worry about in the near term from a dividend perspective.
Consider getting our latest analysis on Cisco Systems’s financial position here.
One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well – nasty. Looking at the last decade of data, we can see that Cisco Systems paid its first dividend at least nine years ago. Its dividend has not fluctuated much that time, which we like, but we’re conscious that the company might not yet have a track record of maintaining dividends in all economic conditions. During the past nine-year period, the first annual payment was US$0.24 in 2011, compared to US$1.40 last year. This works out to be a compound annual growth rate (CAGR) of approximately 22% a year over that time.
We’re not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.
Dividend Growth Potential
Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it’s great to see Cisco Systems has grown its earnings per share at 11% per annum over the past five years. Earnings per share have been growing rapidly, but given that it is paying out more than half of its earnings as dividends, we wonder how Cisco Systems will keep funding its growth projects in the future.
Dividend investors should always want to know if a) a company’s dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. Cisco Systems’s payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we’d like. Overall we think Cisco Systems is an interesting dividend stock, although it could be better.
Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. As an example, we’ve identified 2 warning signs for Cisco Systems that you should be aware of before investing.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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