Cisco To Return Half Of Its Cash Flow To Investors

Aug.16.12 | About: Cisco Systems, (CSCO)

On Wednesday in the after hours, Cisco (NASDAQ:CSCO) announced its quarterly earnings. The numbers were quite impressive as the company posted a huge growth rate in every part of the world with the exception of Europe (of course). What impressed me more was the fact that Cisco made an announcement that should make many of the company's investors happy. According to the announcement, the company will try to return half of its cash flow to investors in terms of dividends and stock buybacks from now on. Accordingly, the company's dividend rate will increase by 74% starting this quarter.

In the previous quarter, the company wasn't very optimistic about the global economy, particularly in Europe. This had caused a lot of worrying amongst the investors of the company, many of who dumped their shares in a panic mode. This quarter, the company's management was more optimistic, even though they continued to remain cautious in the short term. The company posted a revenue increase of 4% and profit increase of 56% in the last quarter compared to the same quarter a year ago.

Cisco currently sits on loads of cash. The company's cash and equivalents are valued at $48 billion, nearly half of the company's market value of $100 billion. The company has every resource to return money to its investors; however, it is good to keep in mind that as the company keeps most of its cash outside of the US, it will have to pay high taxes to bring the money back to the country.

During the dot.com bubble, Cisco was one of Wall Street's favorite stocks. At some point, the company's market value was as high as $600 billion and many people thought that it would be the first company ever to reach a market cap of a trillion dollars. In other words, it was regarded as Apple (NASDAQ:AAPL) is today. Once the dot.com bubble ended up bursting, there was too much panic and fear regarding Cisco. The company's share price fell from $80 to $12 and many investors lost too much money on their trade. After that, the investors became overly cautious about Cisco, keeping the company undervalued for years. Even during the peak of 2007, the highest share price for the company was around $33. Every time Cisco fails to beat analyst estimates, the investors remember the dot.com bubble era and dump their Cisco shares. For this reason, Cisco is one of those companies that is almost always undervalued (another company in this situation is Ford (NYSE:F)).

The company continues to be cautious regarding Europe as the continent will drag down the growth of the company for at least a few years. Of course, Cisco is doing really well in the rest of the world. The company also engages in cost cutting measures including laying off people and restructuring some of its units. Last year, Cisco let go of 15% of its workforce and last month it announced it will let go another 1,300. Cisco wants to become leaner and meaner as it wants to return as much value to its investors as possible. Currently investors are celebrating Cisco's recent news and the stock price is up by 8%.

Cisco's new dividend yield will be around 3%. Of course, if the share price continues to rally like it is currently doing, the yield might come down, but I don't think any of the company's investors would actually complain about such a thing. I personally wouldn't.

Cisco is a value company, just like Microsoft (NASDAQ:MSFT) is. It is not a growth company like Apple or Priceline (NASDAQ:PCLN). Of course this doesn't make it a bad investment. Those seeking for a relatively safe investment (even though there is no such thing as totally safe investment) may find a lot of value in this company. The company might not post double-digit revenue growth every year; however it will continue to post strong results and healthy cash flow for years to come.

I am long Cisco and I keep increasing the number of shares of this company every time it sees a correction. This is one of the better value plays out there and now the higher rate of dividend will make it an even more attractive value play. Once the higher rate of dividend sets in, I expect far less volatility in this company's share price.

Many people don't see much value in share buybacks but there is a lot of value in them. If a company reduces amount of outstanding shares by 5% every year while maintaining its market value, by definition each share will be 5% more valuable every year. Also, buybacks help increases in earnings per share, cash per share and other "per share" metrics. I like buybacks nearly as much as dividends.

Disclosure: I am long CSCO, MSFT, AAPL, F, PCLN.