2021 was a year that Cisco Systems (NASDAQ:CSCO) investors would like to repeat a few times over given the stock's history between early 2000s and 2017 when it was range bound in the $20s and $30s. Over the past year, the stock is up an impressive 45%, beating even the impressive S&P 500's return by more than 50%.
How does 2022 look for Cisco? Let's take a look at what Cisco has going for it, the risks and a trade we are evaluating on Cisco.
Cisco's FY Q1 earnings report had a slew of bad news for investors including supply chain issues, margin contraction in both services and products, and a downward Q2 guidance. Buried beneath the headlines is perhaps a silver-lining that offers some hope. Cisco has been trying to expand its product footprint by expanding into the 5 new categories shown in the middle column below.
(Source: Cisco Investor Relations)
In FY 2019, Products contributed 33% to the annual recurring revenue [ARR]. In two years, this has grown to about 42% thanks to the efforts mentioned above.
(Source: Cisco Investor Relations)
Why is this important?
- Products tend to have higher margins than services over time.
- This almost always results in a higher market multiple.
- Services can be leveraged to support the products (meaning one arm of the business complements the other but the other way around is much harder).
- Products are stickier, meaning harder to replace than services.
Breakout from decade long range
Investors may recall that it wasn't long ago that fellow "old age" technology stocks Microsoft (MSFT) and Intel (INTC) were stuck in their own trading range in the $20s. Of course, Microsoft is a totally different beast today than it was in the past but the focal point is that strong companies that breaks out after very long consolidation tend to form a new higher base.
Given CSCO's breakout from its 15 year long trading range in $20s and $30s, the stock may have finally found a new higher bottom while setting itself up for a nice move higher in 2022. The stock is comfortably trading higher than its 20, 50, 100, and 200 day moving averages, suggesting a strong uptrend.
Dividend Growth and Upcoming Increase
The 10 year dividend growth chart shown below has the slow and steady upward trajectory that dividend growth investors look for. However, the dividend growth rate [DGR] has gone down every year since 2016 with the last two increases averaging about 3%.
Cisco tends to announce its annual dividend increase in February. If the company continues its recent (two year) anemic DGRs and the quarterly dividend continues to raise by a cent each year, the yield on cost reaches 2.64%.
(Source: Table compiled by author with current dividend data from Seekingalpha.com)
However, if the company returns to its 5 year DGR, then the yield on cost raises to a more respectable 3.37%. As stated in some of our previous articles, yield on cost may not mean much to the "present" value of a stock at any given point but we look at it to set our base safety net. Despite earnings pressure expected in 2022, Cisco does have the margin for higher dividend increases based on EPS projections as well as its famous (sometimes notorious) cash pile.
All factors combined, it is not a surprise that Cisco gets an "A" in Seeking Alpha's dividend growth ratings.
- This article by SA author nicely summarizes the risk for Cisco, the business and its stock. The aptly titled article "More of the same" and comments stream highlight the doubts about
- the company's ability to follow through on its product plans
- the nominal acquisitions,
- and questions about CEO Chuck Robbins.
- The huge cash pile referenced in the dividend section above may also be eroding shareholders' value. The Cisco of today is no Berkshire (BRK.B) of the past (or today) where investors can be confident that each dollar retained will be more profitable in operations than being returned to shareholders.
Consider selling puts
Cisco has long been one of our favorite stocks to sell puts on, with the primary reasons being the stock's range bound nature (until recently) and its strong dividend growth rate. Neither of those factors apply to Cisco at present but if you would like to acquire Cisco but at a lower price, selling puts maybe your best ally. Options are generally viewed as risky and complicated by many long term investors. However, once the risks are understood, options can go hand in hand with fundamental and long term investing. Hard to believe? Even the god of "Buy and Hold" investing, Warren Buffett, has used this strategy successfully.
Consider selling puts only under these conditions (all three should be met):
- The underlying stock is something you'd like to own, if assigned.
- The strike price is something you are comfortable with.
- Your puts are cash-secured, meaning you have enough cash to buy the underlying stock should your strike price be met on the expiration date.
Thanks to readers of our previous article on selling puts, please be wary of company specific known events like the ones below before selling a put:
- Upcoming ex-dividend date before the put option expires, as the dividend amount getting deducted from the share price puts the stock closer to the option's strike price.
- Upcoming earnings release near the option expiration date, as the volatility increases.
Below is a put we are evaluating on Cisco. To explain this in plain words, we need to set aside $6,000 to be able to buy 100 Cisco shares at a strike price of $60. Mr. Market is willing to pay us a premium of $114 for this. That's an approximate 2% return in a month and a half's time on the $6,000 we need to set aside for this contract. Please bear in mind that the longer the time to expiration and higher the strike price, the greater the premium. But, we prefer options that expire in 30 to 60 days as it provides us the sweet spot between the weeklies and options that expire year from now. Weekly options offer almost no time to react for non-full time traders while long dated options tie up too much capital in one place for a long time.
Coming back to this example,
- Should Cisco trade above $60 when the option expires on Feb 18th 2022, this put will expire worthless and we retain the ~ 2% premium, which is not too shabby for a month and a half.
- Should Cisco trade below $60 when the option expires on Feb 18th 2022, we'd be obligated to buy 100 shares at $60, irrespective of the market price then. However, with the premium collected, our break even price for this trade is $58.86 ($6,000 minus $114 divided by 100 shares).
- There is also a third way this option chain can be closed and that's called "Buying to close" where if we believe we've netted significant portion of the premium, we'd close out the position before Feb 18th, 2022, and repeat the process at a different expiration/strike price combination.
The dividend increase expected in February may act as a minor catalyst to the stock price if Cisco surprises with a large dividend increase. Even if the dividend is increased to just 38 cents per share (for an annual dividend of $1.52 per share) and the stock is assigned to the investor at $60 when the put option expires, the yield works out to 2.53%.
Cisco, as a stock, is almost in the middle of nowhere. There are reasons to be optimistic at least about 2022 if not beyond as Seeking Alpha has covered here. Cisco is never again going to be the beast it was in the 1990s. It is not yet a dividend aristocrat that may get the attention of most dividend growth investors and retirees. It is not yet too cheap. It is not yet a Microsoft that has turned around after decade(s) of no return. But the keyword maybe the bolded one in the last three sentences above: yet. Cisco is showing promises of becoming a dividend king in the making while working on its turnaround and maybe worth a consideration, especially during sell offs.