"The best way to compound in the stock market is not to worry about what "the market" is doing… or what a business' share price was eight years ago… It's to buy elite businesses at great prices and let the reinvestment of dividends snowball your money." (Brian Hunt, Editor and Chief, Stansberry & Associates, Jan. 20, 2012)
It still amazes me that one of the greatest technology franchises of all times, Cisco Systems (NASDAQ:CSCO), pays a respectable dividend that yields nearly 2.7%. That represents a payout ratio of only 25% of its earnings as of the most recent quarter ending on Jan.26, 2013.
If you reinvest the dividend (many brokerage firms like Fidelity Investments offer this service at no cost) you'll begin the strategy of "compounding" in the stock market. Even though CSCO is trading at a new 52-week high based on the intra-day price on March 7, 2013, the share price trades at only 12 times forward (1-year) earnings and CSCO has loads of cash with which it can keep raising its dividend.
But what if CSCO's share price corrects 7% down to about $20.34? Then you can buy another tranche with a yield-to-price that moves it closer to 3%. Will CSCO correct at some point? Absolutely, but since the stock market is in bullish mode now, with the approach I've described you can feel safer starting a position in CSCO even at the current price level.
Fundamentally, CSCO is a company that is gradually shifting to a revenue model that is expanding to include software, application networking services, cloud and systems management, security solutions and collaboration technology. Analysts expect margins in these divisions to offset the competitive pressures in its networking and router division.
What is especially promising for CSCO's earnings is its "Cisco Collaboration Architecture" which establishes a collaboration core that powers compelling experiences both within and among organizations. Cisco's model involves working together in a modular fashion.
With these modular capabilities it empowers its customers to develop an investment plan that helps ensure what it calls "inter-operability with your existing assets". This is a time and money-saving program that according to the company is already adding to its bottom line profits.
The most recent quarters operating margin of nearly 22% and a year-over-year earnings growth of 44% give credence to the idea that CSCO is "on a roll" that has a long way to go. Yet analysts' consensus estimate on EPS for the quarter that will end in April 2013 is very modest (up 1 cent per share from the year ago quarter). Revenue and sales growth is only estimated to improve by around 5%. Clearly there is room for yet another upside surprise.
As the one-year chart above indicates, CSCO has moved up to a possible new trading range that should allow for some dollar-cost-averaging opportunities for investors who systematically accumulate shares.
Oracle Corp. (NASDAQ:ORCL) is another legendary member of "The Technology Hall of Fame". It not only is a software "star" but it has a profitable foot-hold on the hardware side of the ever-expanding business and personal technology world.
ORCL makes its fortune as it develops, manufactures, markets, hosts, and supports database and middleware software, applications software, and hardware systems. It licenses database and middleware software, including database and database management, application server and cloud application, service-oriented architecture and business process management.
Its business intelligence, identity and access management services, data integration, and Web experience management is why ORCL claims that it "... provides the world's most complete, open, and
integrated business software and hardware systems." Looking at its website products list is a remarkable reminder of how many ways it has created for recurring revenue streams.
One negative about ORCL from an investor's perspective is that it pays a puny dividend (24 cents per year) representing a miserly payout ratio of only 11%. That may also be part of the upside potential for the stock's price however. If an activist shareholder or a group of shareholders press the company to raise its dividend payout, the share price may respond accordingly.
The company has also helped support its share price with regular share buybacks. Some analysts believe that its lucrative software licensing model which produces a high recurring revenue rate is not fully factored into the share price and is under-appreciated.
As of the quarter ending Nov.30, 2012, ORCL had an operating margin of more than 38% and year-over-year quarterly earnings growth of nearly 18%. The next earnings announcement date is March 20th and the consensus analysts' estimate for EPS is for a 4 cent increase over the year-ago quarter. Revenue and sales growth is anticipated to increase by a modest 4%.
Those who want to begin accumulating shares of ORCL may consider looking for a pull-back to the March 1, 2013 intra-day low of $34. Or, buy a little now and more if and when the share price corrects, which may happen after the upcoming earnings report.
When you buy "elite businesses" at reasonable prices during times of economic recovery and monetary easing your chances of pleasing total returns are definitively enhanced. Cisco and Oracle are two such businesses with very bright leadership and business models.
Disclosure: I am long CSCO, ORCL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.