By Ahmed Ishtiaq
Data networking industry has been suffering since the recession, and revenues have fallen at an average rate of 3.5% per year. However, Cisco Systems (NASDAQ:CSCO) has recorded revenue growth of 3% over the same period of time. The industry has changed direction in the past four years. At the moment, the biggest opportunities are in the cloud segment. Cisco is expanding into the cloud segment and getting a strong foothold in the market. The company has expanded upon its products like routers and networking software to large-scale data servers and video conferencing.
Cisco is trying to become a major player in the cloud segment, and it has been acquiring smaller companies operating in the segment. The company has been outperforming its peers over the past year, and it has posted better than expected earnings. With strong expected growth in the cloud segment, Cisco will have substantial growth opportunities to exploit.
Along with solid growth opportunities, Cisco offers an attractive dividend yield. At the moment, the company pays an annual dividend of $0.54 per share, yielding 2.76%. At the end of the second quarter last year, the company increased its quarterly dividend by 75%. It was one of the biggest dividend hikes in the market, and took its quarterly dividend to $0.14 per share from $0.08 per share. Cisco dividends are incredibly strong and the company is in a solid financial position. For any company to maintain its dividends, the payout ratio should be low. I always look at the payout ratio based on free cash flows to evaluate the dividends of a company.
Cisco has extremely strong cash flows. The company generated $10.4 billion in free cash flows over the past twelve months, and paid $1.9 billion in cash dividends. Furthermore, Cisco repurchased common stock worth $3.2 billion. The payout ratio including cash returned to investors in the shape of stocks repurchased stands at 49%, in line with the target payout ratio of 50% set by the company. However, the payout ratio based on only cash dividends stands at 18%. The low payout ratio gives Cisco a lot of room to increase its dividend payments in the future. However, the company may not increase dividends in the near future due to acquisitions. Cisco is making a lot of acquisitions and the company may want to reserve cash for further acquisitions and expansion.
Becoming a Major Player in the Cloud Segment?
The cloud market is expected to be worth $177 billion by the end of 2014. Moreover, it is estimated that global data demand will grow by 80% annually in mobile data traffic over the next five years. Cisco has enormous infrastructure, which puts it in an incredible position to exploit this growth opportunity. Currently, the company captures over 60% of this market. Cisco is trying to increase its strong services business, and the company is adding cloud-based business to the portfolio. During the last two months of 2012, Cisco made four acquisitions.
Bigger technology companies have been acquiring small, but proven, technology companies. At the same time, these big companies have been decreasing research and development expenses. Cisco is trying to grow through acquisitions to capture the massive growth opportunity in the market. Organic growth is solid but acquisitions allow the companies to grow at a fast pace. Cisco is buying the intellectual property from smaller players and adding them to its already impressive portfolio.
Comparison with Peers
Debt to Equity
Cisco is trading at attractive price multiples at the moment. The stock is trading at a discount compared to its competitors. Furthermore, the company has strong margins and improving profitability.
Cisco has been reporting impressive profitability figure, and the company has improved its margins substantially over the past two years. Cloud-based technologies will further enhance its profitability and the company will show substantial growth during the year. I expect Cisco to continue its impressive growth. I expect the stock to cross $25 mark by the mid of 2013. At current price levels, Cisco provides a great opportunity to make solid gains.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: EfsInvestment is a team of analysts. This article was written by Ahmed Ishtiaq, one of our equity researchers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.