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Using a Value Line Report: Cisco Systems, a Dividend Growth Story in the Making
Investors looking for dividend growth normally search out companies that have increased their dividend disbursements for many years. This focus makes complete sense, since a company that has a long history of increasing its dividend payments is logically more likely to continue that trend over time. Indeed, this is the reason why lists of so called “dividend achievers” and “dividend aristocrats” are so popular. (So-called ”achievers” have 10 years of consecutive increases, “aristocrats” have 25 years.)
However, by the time a company has a decade of dividend increases under its belt, the rate of dividend increases usually begins to slow somewhat. This is problematic for investors looking to build an income stream to support retirement needs, particularly if other aspects of their portfolios are held in securities lacking distribution growth, such as bonds. That isn’t to suggest that dividend growth at a long-time dividend grower won’t be material enough to outpace inflation, but that increases from the equity component of a portfolio may not be enough to make up for the lack of growth in other areas.
The paradox is that truly robust dividend growth usually happens in the first few years after a company starts paying dividends. While dividend growth in the high single digits is impressive for a long-time payer, it isn’t uncommon to see dividend increases in the 20% to 50% range, and even 100% on rare occasions. A great example of this is Dow-30 component Cisco Systems (CSCO – Free Cisco Systems Stock Report).
The technology giant started paying dividends regularly in 2011, which can be seen in the Quarterly Dividend Box. The payment started at $0.06 per quarter, leading to a somewhat modest yield. Then, in the second quarter of 2012, the quarterly dividend was increased to $0.08 per share—a 33% increase. That’s an impressive figure, to be sure, but nothing compared to the recent announcement that the quarterly dividend was going to go from $0.08 to $0.14, a 75% increase. Going back to the six cents paid in the first quarter would yield an increase of 133%! This information was reviewed in the recent Supplementary report issued by Value Line to update subscribers on Cisco’s quarterly earnings release.
So, in less than 12 months, the stock has gone from yielding under 1% to above 3%. This is nothing short of impressive, but, frankly, is not likely to repeat itself any time soon. That said, the company has made a public commitment to return cash to shareholders that, assuming continued operating success, will lead to more dividend increases. Indeed, analyst Kevin Downing projected that revenues and earnings will grow at an annualized rate of 7.5% and 9.0%, respectively, over the next three to five years (projected and historical growth rates can be found in the Rates box). Dividend increases in that range are reasonable to expect. Investors looking for a technology stock that looks like it will someday have a long history of dividend increases behind it, might want to take a look at Cisco.
The bigger question on investors’ minds, however, should be how one finds companies poised for large dividend increases. For starters, the financial strength of a company is core to its ability to pay dividends. Continuing to use Cisco as an example, it earns Value Line’s highest rating (A++) for Financial Strength, which can be found in the Ratings box. Note, too, that its debt load is reasonable at 26% of total capital (found in the Capital Structure box) and that the balance sheet has almost $50 billion of cash on it (noted in the Current Position box).
One might pause and ask why a company with so much cash would take on any debt at all. The reason is most likely that a large portion of Cisco’s cash resides outside The United States. Repatriating that money would lead to punitive taxes. Since acquisitions are an important part of the company’s business model, and borrowing rates are at historic lows, taking on low cost debt is actually cheaper than bringing cash back to the U.S. This same dynamic is occurring at many domestically domiciled international companies.
That large cash balance, however, is another important component when seeking out new dividend payers with the potential to materially increase distributions. Clearly, companies with large cash hoards have the ability to increase dividends. They are also more likely to be pressed by investors and the media to disburse those dollars to their owners—the shareholders. This was true of fellow Dow-30 members Microsoft (MSFT – Free Microsoft Stock Report) and Intel (INTC – Free Intel Stock Report), too, before they started to pay dividends.
Note that the three examples are all from the technology industry. This is another attribute to examine. As industries mature, the most successful companies will usually get to a point where returning cash to shareholders becomes a more obvious choice, as avenues for growth become harder to find. Another industry going through this right now is cellular telephone tower owners, such as American Tower Corporation (AMT), which recently converted to a real estate investment trust—creating a legal mandate to return cash to shareholders in return for the avoidance of corporate taxation. Others in the cell tower industry are examining similar conversions.
Although there is nothing wrong with dividend growth in the high-single digits, investors looking to truly supercharge their dividend portfolios can do so by looking at freshly minted dividend paying companies. Seeking out companies with large cash balances, management support for the dividend policy, and maturing industries is a good starting point.
At the time of this articles writing, the author did not have positions in any of the companies mentioned.