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In 2011, Cisco Systems (NASDAQ:CSCO) instituted its quarterly cash dividend program and it has not looked back since. The initial dividend was set at six cents per quarter and has since been raised three times. The latest increase, from 8 cents quarterly to 17 cents quarterly was rather aggressive and took some analysts and investors by surprise. But those shareholders who have been carefully monitoring the company's cash flow and capital allocation plan, can clearly see that the effort to boost the dividend payout will only increase from here.

In this article we will explore Cisco's balance and income sheets as well as current management plans to explain why Cisco will likely increase its dividend by over 100% in the next few years without skipping a beat.

The Path to Higher Payout

Cisco had net income in 2013 of almost $10 billion. Net operating cash flow was $12.9 billion. They have been working actively on their share buyback program and have been able to reduce outstanding common shares from 5.655 billion in 2010 to 5.389 billion as of the third quarter of 2013. Cisco's strong income growth combined with their share repurchases have helped the company increase earnings per share from $1.05 in 2009 to $1.86 in 2013. Cisco has had a stock buyback program in place and buying shares in the public market since 2002. Over the last 11 years the company has bought back almost 79 billion dollars worth of shares. This has served to stabilize the share price during difficult times and to boost performance. Moreover, as the company continues to repurchase its shares, its dividend payout is likely to continue rising.

Payout Ratio

The chart below shows Cisco's payout ratio for the last years.

Over the last three years we can see that Cisco has been increasing it's payout ratio aggressively each year. This could perhaps be because the company is having trouble effectively using its large cash reserve to drive further growth, whether it be through acquisitions or internal growth. It could also be that Cisco is looking to drive it's share price higher by increasing it's overall dividend yield. This has certainly helped drive shares higher in the last 2 years, as the share price has increased by about 50% since the summer of 2011, around the time when the initial dividend plan was implemented. While the shares have still been trading in a range for the last decade, it is managements hope that the company's continued growth in addition to an aggressive share buyback program and increasing dividend payout help to propel share prices higher.

Furthermore, when compared to other large tech companies like Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC) or Texas Instruments (NASDAQ:TXN), we notice that Cisco currently has a payout ratio which is below average. Although it has climbed in recent years, Cisco still has a lot of room to go in expanding its payout ratio.

Expectations

Cisco's continued earnings growth and a strong buyback program will drive earnings per share higher at an accelerated rate. Cisco will also continue making an effort to boost it's payout ratio so it can be more in line with other large tech companies. This will force Cisco to directly boost the dividend on a yearly basis simply to maintain the same nominal payout level which it is currently offering. Considering these factors and taking into account analysts future earnings estimates for Cisco, we can estimate the future dividend payments in the years to come.

Considering the following estimates and assuming an expected future payout ratio of 45%, we can calculate the yearly dividend payments as follows.

Under the above conditions, Cisco can be expected to have a yearly dividend payment in 2016 of about $1.00, or a quarterly payment of 25 cents. This would represent an increase of 47% over the current dividend. However, I strongly believe the analysts are underestimating Cisco's future dividend potential and I think that it is likely that Cisco will be able to raise its dividend rate to 35 cents per quarter by 2016.

Management to Boost Profits

Cisco's stock price has been battered in recent years by heavy competition in its core market by Juniper Systems (NYSE:JNPR), HP (NYSE:HPQ) and Huawei. As those competitive threats subside and Cisco focuses on growing its market share and containing costs, management will be able to drive profits at a far greater rate than revenue growth. Operating margins will likely expand moderately from the approximate 28% where they currently sit.

Furthermore, Cisco has recently announced 4000 job cuts and some analysts believe this will just be the beginning. As part of CEO John Chambers' growth strategy for the company, the cuts are a central part in the plan to "realign resources" within the company. Rather than focusing on gaining market share in every aspect of the market, Mr. Chambers will focus attention on areas which show the fastest growth and largest opportunities. Through continued strategic layoffs and overhead cost reductions, Cisco should easily be able to reduce costs by a further $1 billion in the short run.

Conclusion

With the cost cutting and income growth expected to continue, Cisco will be able to greatly increase profits in the years to come. It would not be unlikely for earnings per share to reach $2.50 by 2016. Considering also that Cisco will be actively working to reduce it's outstanding share count as well as increase its payout ratio, a common dividend of at least 35 cents per quarter or $1.40 per year is absolutely possible. This would represent a doubling from Cisco's 2013 dividend payout of 68 cents per share. Currently, Cisco's share price stands at about $24, representing a future expected dividend yield of 5.8% in 2016. For patient investors looking for dividend growth and price appreciation, Cisco Systems is sure to please.

Source: Cisco's Dividend To Explode Higher