Cisco Systems: Dividend Dynamo or the Next Blowup?

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Dividend investing is a tried-and-true strategy for generating strong, steady returns in economies both good and bad. But as corporate America's slew of dividend cuts and suspensions over the past few years has demonstrated, it's not enough simply to buy a high yield. You also need to make sure those payouts are sustainable.

Let's examine how Cisco (NAS: CSCO) stacks up. In this series, we consider four critical factors investors should examine in every dividend stock. We'll then tie it all together to look at whether Cisco is a dividend dynamo or a disaster in the making.

1. Yield
First and foremost, dividend investors like a large forward yield. But if a yield gets too high, it may reflect investors' doubts about the payout's sustainability. If investors had confidence in the stock, they'd be buying it, driving up the share price and shrinking the yield.

Cisco yields 1.2% -- not bad, but a bit less than the S&P 500's 2.1%.

2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company paid out in dividends last year to the earnings it generated. A ratio that's too high -- say, greater than 80% of earnings -- indicates that the company may be stretching to make payouts it can't afford, even when its dividend yield doesn't seem particularly high.

Cisco has a payout ratio of 15%. This may seem modest, but it's important to remember that Cisco also spends a considerable amount (about 6 times as much) on share buybacks.

3. Balance sheet
The best dividend payers have the financial fortitude to fund growth and respond to whatever the economy and competitors throw at them. The interest coverage ratio indicates whether a company is having trouble meeting its interest payments -- any ratio less than 5 is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.

Let's see how Cisco stacks up next to its competitors:

Company

Debt-to-Equity Ratio

Interest Coverage

Cisco Systems,36%14 times
Brocade Communications (NAS: BRCD) 39%2 times
Juniper Networks (NAS: JNPR) 14%N/A
F5 Networks (NAS: FFIV) 0%N/A

Source: S&P Capital IQ.

Tech companies generally don't carry very much debt, partly because they tend to be less capital-intensive businesses than, say, steel production, but also because in a sector subject to rapid technological change, flexibility is critical.

Cisco, Juniper, and F5 all carry light debt burdens. Brocade also doesn't have a high debt-to-equity ratio, but its operating profits are quite small relative to its interest payments.

4. Growth
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.

Company

5-Year Earnings-Per-Share Growth

Cisco Systems4%
Brocade Communications(17%)
Juniper Networks(5%)*
F5 Networks29%

Source: S&P Capital IQ.
*3-year growth.

It's somewhat rare for tech companies to pay a dividend. Cisco only began paying one in March; none of the other three does so.

The Foolish bottom line
Though it's not exactly a dividend dynamo because of its modest yield, as a young dividend payer, Cisco exhibits a fairly strong dividend bill of health. It has a low payout ratio and a manageable debt burden. For now, the company has been opting to return money to shareholders -- and executives -- by buying back stock, so investors looking for a higher yield will want to keep an eye on those buybacks and see how well the company is able to grow its earnings.

If you're looking for some great dividend stocks, I suggest you check out "Secure Your Future With 11 Rock-Solid Dividend Stocks," a special report from The Motley Fool about some serious dividend dynamos. I invite you to grab a free copy to discover everything you need to know about these 11 generous dividend payers.

At the time this article was published Ilan Moscovitzdoesn't own shares of any company mentioned.The Motley Fool owns, andMotley Fool newsletter serviceshave recommended buying, shares of Cisco Systems. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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