Cisco: Unloved, Undervalued, Misunderstood And Loads Of Income Stream Potential

Dec.16.13 | About: Cisco Systems, (CSCO)

This article is going to focus on how even unloved, undervalued, disrespected dividend paying companies can make you oodles of cash, if an investor has a long-term outlook and strategy. The company used in this example and for the propose of this article is Cisco Systems (NASDAQ:CSCO).

Cisco is the ultimate "dog," pretty much trading in a range of about $15 to $30 for the last dozen years. This is the source of disrespect number one. The view is there is no growth, but the safety of a strong floor in the price and knowledge that Cisco is going to be a survivor through crises (it has already prevailed through the tech bubble burst and the financial crisis) seems to be ignored. The latter is what investors should be focused on today in my opinion. And that is its stability.

The source of disrespect number two is that Cisco is an extremely conservative company in company specific projections and economic world views. You never feel good when the CEO of a company you own springs a surprise 4,000 position layoff or lowers earnings guidance. However, Cisco has done this year after year, conference call after conference call. They prefer to under promise and over deliver. The last thirteen quarters they beat the average consensus estimates six times and met the average consensus estimates seven times. There were no misses in this time period.

Disrespect number three is that Cisco is committed to investor payouts and is not rewarded for it. Since CIsco initiated a dividend back in 2011 its CAGR of the dividend is 41.5% with a still low payout rate of 37%, which means more increases are coming as Cisco is poised to become a dividend challenger soon. The company has also been committed to share repurchases.

Below is a residual earnings model with projected share prices if meeting analyst estimates, beating analyst estimates by 5% and 10%, and missing analyst estimates by 5% and 10%. The price range from the model is consistent with how Cisco has traded the last decade, although I feel the price target for the 10% miss scenario is extremely unlikely.

Year 2013 2014 2015 2016 2017 2018 Current Stock Price $20.24
Net Tangible Assets $31,258,000,000.00 Shares Outstanding 5,300,000,000
Earnings $1.98 $2.08 $2.24 $2.57 $2.86 Stock: CSCO
Dividends $0.75 $0.825 $0.90 $1.00 $1.10
Earnings Growth 5.05% 7.69% 14.73% 11.28%
Book Value/per share $5.90 $7.13 $8.38 $9.72 $11.29 $13.05
ROCE 33.57% 29.18% 26.72% 26.43% 25.33%
CAPM (discount rate) 11.87% 11.87% 11.87% 11.87% 11.87%
Residual Earnings $1.28 $1.23 $1.24 $1.42 $1.52
P/B Ratio 3.43 2.84 2.41 2.08 1.79 1.55
Analyst Estimates
Book Value/per share (previous year) $5.90 CAPM
PV Residual Earnings (current year) $1.14 Risk-Free Rate/WACC 2.1900%
PV Residual Earnings (current year + 1) $1.22 Avg. Return of S&P500 10.00%
PV Residual Earnings (current year + 2) $1.38 Market-Risk Premium 7.81%
PV Residual Earnings (current year + 3) $2.56 Beta 1.24
PV Residual Earnings (current year + 4) $4.62 CAPM 11.87%
5 Year Target Price $16.81
Year 2013 2014 2015 2016 2017 2018
Net Tangible Assets $31,258,000,000.00
Earnings $2.08 $2.18 $2.35 $2.70 $3.00
Dividends $0.75 $0.83 $0.90 $1.00 $1.10
Earnings Growth 5.05% 7.69% 14.73% 11.28%
Book Value/per share $5.90 $7.23 $8.59 $10.04 $11.74 $13.64
ROCE 35.25% 30.22% 27.39% 26.88% 25.59%
CAPM (discount rate) 11.87% 11.87% 11.87% 11.87% 11.87%
Residual Earnings $1.38 $1.33 $1.33 $1.51 $1.61
P/B Ratio 3.43 2.80 2.36 2.02 1.72 1.48
Analyst Estimates + 5%
Book Value/per share (previous year) $5.90 CAPM
PV Residual Earnings (current year) $1.23 Risk-Free Rate/WACC 2.1900%
PV Residual Earnings (current year + 1) $1.40 Avg. Return of S&P500 10.00%
PV Residual Earnings (current year + 2) $1.69 Market-Risk Premium 7.81%
PV Residual Earnings (current year + 3) $3.29 Beta 1.24
PV Residual Earnings (current year + 4) $6.16 CAPM 11.87%
5 Year Target Price $19.67
Year 2013 2014 2015 2016 2017 2018
Net Tangible Assets $31,258,000,000.00
Earnings $2.18 $2.29 $2.46 $2.83 $3.15
Dividends $0.75 $0.83 $0.90 $1.00 $1.10
Earnings Growth 5.05% 7.69% 14.73% 11.28%
Book Value/per share $5.90 $7.33 $8.79 $10.35 $12.18 $14.23
ROCE 36.93% 31.23% 28.04% 27.31% 25.83%
CAPM (discount rate) 11.87% 11.87% 11.87% 11.87% 11.87%
Residual Earnings $1.48 $1.42 $1.42 $1.60 $1.70
P/B Ratio 3.43 2.76 2.30 1.96 1.66 1.42
Analyst Estimates + 10%
Book Value/per share (previous year) $5.90 CAPM
PV Residual Earnings (current year) $1.32 Risk-Free Rate/WACC 2.1900%
PV Residual Earnings (current year + 1) $1.61 Avg. Return of S&P500 10.00%
PV Residual Earnings (current year + 2) $2.05 Market-Risk Premium 7.81%
PV Residual Earnings (current year + 3) $4.16 Beta 1.24
PV Residual Earnings (current year + 4) $8.10 CAPM 11.87%
5 Year Target Price $23.13
Year 2013 2014 2015 2016 2017 2018
Net Tangible Assets $31,258,000,000.00
Earnings $1.88 $1.98 $2.13 $2.44 $2.72
Dividends $0.75 $0.83 $0.90 $1.00 $1.10
Earnings Growth 5.05% 7.69% 14.73% 11.28%
Book Value/per share $5.90 $7.03 $8.18 $9.41 $10.85 $12.47
ROCE 31.89% 28.11% 26.02% 25.95% 25.04%
CAPM (discount rate) 11.87% 11.87% 11.87% 11.87% 11.87%
Residual Earnings $1.18 $1.14 $1.16 $1.32 $1.43
P/B Ratio 3.43 2.88 2.47 2.15 1.87 1.62
Analyst Estimates - 5%
Book Value/per share (previous year) $5.90 CAPM
PV Residual Earnings (current year) $1.06 Risk-Free Rate/WACC 2.1900%
PV Residual Earnings (current year + 1) $1.04 Avg. Return of S&P500 10.00%
PV Residual Earnings (current year + 2) $1.11 Market-Risk Premium 7.81%
PV Residual Earnings (current year + 3) $1.96 Beta 1.24
PV Residual Earnings (current year + 4) $3.40 CAPM 11.87%
5 year Target Price $14.46
Year 2013 2014 2015 2016 2017 2018
Net Tangible Assets $31,258,000,000.00
Earnings $1.78 $1.87 $2.02 $2.31 $2.57
Dividends $0.75 $0.83 $0.90 $1.00 $1.10
Earnings Growth 5.05% 7.69% 14.73% 11.28%
Book Value/per share $5.90 $6.93 $7.98 $9.09 $10.41 $11.88
ROCE 30.21% 27.01% 25.27% 25.44% 24.74%
CAPM (discount rate) 11.87% 11.87% 11.87% 11.87% 11.87%
Residual Earnings $1.08 $1.05 $1.07 $1.23 $1.34
P/B Ratio 3.43 2.92 2.54 2.23 1.95 1.70
Analyst Estimates - 10%
Book Value/per share (previous year) $5.90 CAPM
PV Residual Earnings (current year) $0.97 Risk-Free Rate/WACC 2.1900%
PV Residual Earnings (current year + 1) $0.88 Avg. Return of S&P500 10.00%
PV Residual Earnings (current year + 2) $0.87 Market-Risk Premium 7.81%
PV Residual Earnings (current year + 3) $1.48 Beta 1.24
PV Residual Earnings (current year + 4) $2.45 CAPM 11.87%
5 Year Target Price $12.54
Click to enlarge

The Graham number has a price target of $14.06. Now we know why Berkshire Hathaway hasn't bought Cisco. But again I feel the Graham number price target is also unlikely to occur as the P/E would be 7.6 and the forward P/E would be 7.1 at that price. Cheaper than dirt! The trailing P/E is currently 11.01 and forward P/E is 9.73 with a 3.2% yield. Still pretty much dirt cheap, Not to mention the last quarterly dividend payment was only 34.5% of total cash flows from operations leaving more than $1.7 billion of cash in Cisco's coffers quarterly.

The Graham Number
Constant 22.5
Diluted EPS of previous year 1.49
BVPS $5.90
$14.06
Click to enlarge

Perhaps a better model going forward to value Cisco with is the discounted dividend model. It appears investors may still be using the residual earnings model which would be less appropriate for a mature, lower growth company that now pays a reliable and growing dividend. If I use a dividend growth of 10% (much lower than the current CAGR of 41.5% for Cisco's dividend) a year for the next five years and add on a terminal value on year five our target price is $40.11, about 100% of upside potential.

2014 2015 2016 2017 2018 Terminal Value CAPM 11.8700%
Dividend Per Share $0.75 $0.83 $0.91 $1.00 $1.10 $64.59 DG 10.0000%
CAPM 0.1187 0.1187 0.1187 0.1187 0.1187
PV $0.67 $0.66 $0.65 $0.64 $37.49
Target Price $40.11
Click to enlarge

Finally in this next Excel sheet below the power of dividend growth investing is really displayed and shows why investors should have companies like Cisco in their retirement portfolio. For this calculation I assumed very conservative numbers where Cisco's dividend increases for the next fifteen years is 5% a year and drops to 2.5% a year in the fifteen years after that, even though I expect the dividend to increase more than 5% a year in the next five years, at the very least. I also assume that the price will not move one penny from its closing price of $20.24 on 12/13/13 in the next thirty years.

Year Annual Dividend Yearly Smoothed Dividend Growth Assumed Stagnant StockPrice # Of Shares Owned # Of New Shares From Dividend Reinvestment
2013 0.680 5% $20.24 500 16.80
2014 0.714 5% $20.24 517 18.23
2015 0.750 5% $20.24 535 19.82
2016 0.787 5% $20.24 555 21.58
2017 0.827 5% $20.24 576 23.54
2018 0.868 5% $20.24 600 25.73
2019 0.911 5% $20.24 626 28.17
2020 0.957 5% $20.24 654 30.91
2021 1.005 5% $20.24 685 33.99
2022 1.055 5% $20.24 719 37.46
2023 1.108 5% $20.24 756 41.38
2024 1.163 5% $20.24 798 45.83
2025 1.221 5% $20.24 843 50.89
2026 1.282 5% $20.24 894 56.66
2027 1.346 5% $20.24 951 63.26
2028 1.414 5% $20.24 1,014 70.84
2029 1.484 2.5% $20.24 1,085 79.58
2030 1.521 2.5% $20.24 1,165 87.55
2031 1.560 2.5% $20.24 1,252 96.48
2032 1.598 2.5% $20.24 1,349 106.52
2033 1.638 2.5% $20.24 1,455 117.80
2034 1.679 2.5% $20.24 1,573 130.52
2035 1.721 2.5% $20.24 1,704 144.88
2036 1.764 2.5% $20.24 1,848 161.14
2037 1.809 2.5% $20.24 2,010 179.56
2038 1.854 2.5% $20.24 2,189 200.50
2039 1.900 2.5% $20.24 2,390 224.33
2040 1.948 2.5% $20.24 2,614 251.53
2041 1.996 2.5% $20.24 2,865 282.63
2042 2.046 2.5% $20.24 3,148 318.26
2043 2.097 2.5% $20.24 3,466 359.20
Income Stream In Year 30 $7,270.22
Click to enlarge

Based on my conservative numbers and if one started with 500 shares of Cisco today they would end with 3,466 shares at the end of the thirty year period. The dividend at the end of the thirty years would be about $2.10. Multiply your ending shares by the ending dividend at the end of the thirty year period and Cisco would generate $7270.22 of cash flow a year. And this is from one position in your portfolio. If one had five companies in their retirement portfolio of Cisco's ilk then that would be income of $35,000 to $50,000 a year from only five positions in the portfolio that you could live on and enjoy retirement.

While all of these are projections and will definitely not be exact I do believe Cisco is on this path as they are the unquestioned leader in routers, switches and networking and are fortifying the future with timely, smaller buyouts of newer technology companies that should pay dividends (pun intended) in the years to come.

Disclosure: I am long CSCO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.