Cisco Systems (CSCO) has had a great four months, and the stock has gained substantially. At the start of November, the stock was trading below $17 and currently it has gone above $21. Optimism about the future growth of the company has played an important role in the recent increase in the stock price. The company is one of the biggest networking products manufacturers in the world, and currently sells more than half of the routers sold all over the world.
Along with its strong equipment department, the company is focusing on highly lucrative networking services and software segments. Besides the growth opportunity and capital gains, Cisco stock is also extremely attractive to income investors. It is very rare to find an investment, which offers healthy growth opportunity with stable income.
Dividends: Not Fat, But Still Attractive.
Cisco does not have a long history of paying dividends. The company started paying dividends in 2011, and since then, it has twice increased its quarterly dividend payments. Cisco paid its first quarterly dividend of $0.06 per share in April 2011, and after two dividend hikes, the company currently pays a quarterly dividend of $0.14 per share. Cisco's dividend payments have more than doubled in the last two years, and the stock currently yields 2.60%. Dividend yield at 2.60% is not eye-popping and falls behind a number of other companies operating in the market. However, there are few companies that can boast such dividend growth, and future growth potential.
While looking at dividends, I always look at the free cash flows of the company. I believe payout ratio based on free cash flows is a better measure of the ability of the company to grow dividends in the future earnings. In Cisco's case, payout ratio is extremely low. In the last 12 months, the company paid cash dividends of $2.34 billion, and generated free cash flows of $10.74 billion. Currently, Cisco's payout ratio is just below 22%. Payout ratio up to 50% is easily manageable for any company, in my opinion. When we look at Cisco's payout ratio, it is clear that the company has a lot of room to grow its dividends in the future. Cisco can double its dividend payments, and the company will still have a lot of cash to cover its capital expenditures (Capital expenditures have remained around $1 billion in previous five years).
As I mentioned in the intro of this article, Cisco is trying to exploit the most lucrative segment of the market, data services. At the moment, data services is the most rapidly growing segment in the sector. With the help of some acquisitions, the company is becoming an important player in the cloud computing segment. Demand for data services is expected to grow at an exponential rate over the next four years. According to Cisco's mobile data traffic forecast, during 2012, data traffic grew by 70% and video traffic exceeded 50% of the traffic for the first time. The growth in demand for data services is expected to continue at an exponential rate.
Cisco expects the mobile data traffic to grow at a compound annual growth rate of 66% over the next five years, reaching 11.7 Exabytes per month. As a result, companies operating in the sector will benefit heavily. At the moment, the company is experiencing a strong increase in demand in its equipment segment. Especially, the demand for equipment for data centers is getting stronger. At the moment, data center equipment accounts for 4% of the product sales, which is expected to increase in the future. Cisco is executing a very good strategy of increasing revenue from services and software segment. At the moment, revenue from the services segment accounts for about 22% of total revenue. Services segment have shown strong year-over-year growth (12%) in the last two years. I expect revenue from the services segment to grow further and drive future growth for the company.
Cisco's position as the leading equipment and services provider in the sector will allow the company to grow substantially. We are already seeing a substantial improvement in the margins for the company, which should continue as Cisco gains more market share in high-growth segments. Furthermore, the company returns a healthy chunk of cash to its investors through cash dividends and share repurchases. Cisco is an ideal investment to enjoy growth as well as dividends at the moment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.