3 Reasons Cisco Systems Is Becoming a Top Dividend Stock

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Source: Cisco Systems.

In general, technology stocks were slow out of the gate in realizing the powerful attraction that ample dividend yields provide to income investors. Cisco Systems certainly wasn't alone in stubbornly choosing not to pay a dividend throughout the first couple of decades of its history, instead focusing on reinvesting profits into its business. Yet Cisco finally reversed course and started making dividend payouts to shareholders in 2011, and since then, the tech giant has demonstrated that it's serious about rewarding its investors with regular and sizable payouts.

Since the 1990s, Cisco Systems has been a pioneer in networking equipment and services, tying its fortunes to the rise of the Internet. Stronger competition in the tech arena has forced Cisco to up its game in order to keep up with big-tech rivals Oracle and IBM , but Cisco has also aimed at tapping other segments of the tech space in order to broaden its reach and its potential for growth. Let's take a look at three reasons why Cisco Systems is on track to be a top dividend stock.

1. Cisco Systems has made up for lost time by boosting its dividend at a fast pace.
In contrast to IBM, which sports a long dividend history, both Cisco and Oracle are recent newcomers to the dividend scene. Oracle started paying a dividend in early 2009, but Cisco waited until the post-financial crisis recovery had taken hold before paying its first dividend three years ago.

CSCO Dividend Chart

CSCO Dividend data by YCharts.

Once Cisco started paying dividends, though, it didn't hesitate to move aggressively to make them a key component of its capital allocation strategy. After a 33% increase in early 2012, Cisco took the unusual step of implementing an additional 75% boost later that year. Although 2014's 12% raise was small by comparison, Cisco has still more than tripled its quarterly dividend in less than three years -- an impressive feat for any stock. With the current dividend, Cisco yields more than 3%, easily topping IBM and Oracle and putting it in the upper ranks of tech stocks.

2. Cisco has capacity for further dividend increases.
After such a big rise in dividend payments, Cisco might appear to have tapped itself out in terms of future dividend growth. Yet even with modest earnings growth, Cisco's conservative approach toward instituting a dividend payout in the first place has given it more room for increases in the future.

Even based on trailing earnings, Cisco only pays out about half of what it earns, leaving it ample funds for reinvesting in its own business as well as implementing other shareholder-friendly initiatives. For instance, Cisco has greatly accelerated its pace of stock buybacks this year, taking advantage of its weak share-price performance to counteract the upward trend in its share counts due to extensive issuance of shares and options as compensation.

As earnings grow in future years, Cisco's capacity to boost its dividend will grow with it. Yet even if the company sees subpar earnings growth for a period of time, its low earnings payout ratio still gives Cisco room to make dividend increases.

Source: Cisco Systems.

3. Huge growth opportunities could boost Cisco's long-term dividend prospects.
Cisco Systems has a huge opportunity to bolster its future growth, as the Internet of Things starts to build up momentum in the tech community. With the goal of connecting vast networks of equipment to allow remote operation and interaction across the online world, the Internet of Things would involve a huge capital commitment among manufacturers to find ways to provide in-device connectivity seamlessly.

Given Cisco's historical emphasis on networking equipment, it's well placed to provide the backbone of the Internet of Things and define the course of its development. Along those lines, Cisco has invested hundreds of millions of dollars into start-up companies looking at different ways to exploit the Internet of Things once it's established. With efforts to provide cloud data storage, software management services for companies seeking to analyze their own data, and larger-scale projects like smart cities under way, Cisco has the potential for immense growth that could support higher dividends in the years to come.

For a company that has only paid dividends for three years, Cisco Systems makes a strong case for recognition as a top dividend stock. Investors need to see how the company responds to any future downturn in the business, but for now, Cisco is on course to establish itself as a favorite among income investors.

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The article 3 Reasons Cisco Systems Is Becoming a Top Dividend Stock originally appeared on Fool.com.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of International Business Machines and Oracle. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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