I think it was Warren Buffett who said that in the long term the market is a weighing mechanism but in the short term the market is a voting mechanism. Sometimes, the investment community just doesn't bond with a company or a CEO and the market as a "voting mechanism" produces a horrible drubbing at the polls.
That has been the story of late with Cisco (NASDAQ:CSCO) which has taken a horrible beating shortly after most of its recent earnings releases. Ironically, the news has really not been particularly bad. In the latest quarter, results beat estimates, there was strong growth in important segments and the trailing bad news was that sales to public sector entities declined (which should have not been a surprise to anyone other than analysts recovered from comas shortly before the conference call).
CSCO still has overwhelmingly dominant market shares in routers and servers and all sorts of other strong businesses in tech segments that promise strong growth. CSCO still makes enormous margins on its sales. The days of assured double digit growth are probably over, but this is a company which, when net cash is backed out, is trading at less than 8 times earnings.
I tend to be a deep value investor and my holy grail is "private market value" by which I mean the amount an intelligent investor would be willing to pay for the whole company. In calculating this, I have generally treated balance sheet cash as being worth its face value and then tried to separately value the enterprise.
This approach may prove accurate in the long term but in the short term the market is not voting my way. The valuations of Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL) and Cisco (CSCO) make no sense if the companies are given appropriate credit for balance sheet cash. In the short term, there may be some logic to this as there is not an immediately apparent mechanism for shareholder monetization of this value. These companies are too big to be taken over by a private entity. The only tech companies big enough to take them over would face a blistering antitrust inquiry. I am sure that the Chinese sovereign wealth fund would have an interest, but the United States government would certainly hesitate before approving such a deal.
On the other hand, dividends are starting to play a more important role in valuation by attracting investors who are frustrated with low bond yields. It is also probably the case that whatever management says about a company's long term prospects, investors who have been burned in two nasty crashes in one decade will be skeptical.
Dividends, on the other hand, are a kind of "statement" that management is confident of long term prospects. Once granted, there is considerable pressure on management to increase the annual payout and enormous pressure not to decrease the dividend. Shareholders, thus, may gain a degree of confidence that a management which approves a large dividend is also a management which does not foresee a major calamity. It is interesting that the one large tech company which has increased its dividend significantly of late, Intel (NASDAQ:INTC), has been rewarded in the market.
CSCO commenced dividends very recently at the level of 6 cents per share per quarter. A doubling of that dividend would produce an annual payout of 48 cents or a yield of 2.8% on the current price of $16.93. While not as high a yield as that of INTC, it would be significant and it would tend to put somewhat of a floor under the stock. Combined with a statement that the company intends to increase the dividend by between 5 and 10 percent per year, it would attract yield oriented investors.
CSCO can readily afford such action. With 5.5 billion outstanding shares, the increase would cost $1.3 billion a year and produce a total dividend expense of $2.6 billion a year. CSCO has $ 26 billion of net cash and throws off over $8 billion of cash flow per year (I use income plus depreciation and amortization plus increase in deferred earnings minus capex and acquisitions).
If CSCO were spending every last cent on expansion like a start-up or an early stage growth company, there might be an argument for holding onto the cash but that has not been the case for a long time. CSCO's primary use of the cash has been to buy back its own stock at prices much higher than the current market.
And stop the conference calls. For a while at least. The investment community will read the worst into anything John Chambers says. It is not his fault, it may not be the investment community's fault: it is just one of those things.
Short of hiring someone like Jim Carrey or Dane Cook to do the conference call for them, there is no way that these conference calls will be a pleasant experience for CSCO. CSCO has a great business and some other companies have figured out that it is a great business and are trying to steal market share. There is no good way to describe how you are going to deal with that problem during a quarterly conference call. If you say you are going to cut prices, but will make more money in the long run because you will drive the competitors out, you may be met with a subpoena the next morning. If you say you will maintain margins, investors will get concerned that you are about to lose market share. If you try to divert attention to new and growing businesses, that will raise eyebrows because you are not addressing your most important markets.
CSCO should seriously consider simply filing its financials at the SEC and letting the numbers (and the increasing dividends) do the talking.