How Dividends Change the Game for Cisco Shareholders


The wealth-building power of compound interest will never cease to amaze me. It's a story of patience and attention to detail, where small, short-term differences add up to massive divergence over decades. And in the end, the biggest winners don't always deliver the fattest share-price returns.

Today, we'll take a closer look at a newcomer in the dividends game. Say hello to computer-networking titan Cisco Systems .

Cisco started paying dividends just two years ago, so it can't be considered a true dividend aristocrat for another 28 years. But the quarterly payout has nearly tripled in Cisco's young dividend history, rising from the original $0.06 per share to $0.17 per share today. That most recent dividend will be paid out tomorrow to shareholders on record as of May 8. The policy certainly hit the ground running.

The current 2.9% yield places Cisco shoulder to shoulder with Dow peers Johnson and Johnson and JPMorgan Chase , which offer 3% and 2.8% yields, respectively. The trio ranks in the upper half of all Dow yields, with JPMorgan grabbing the 13th spot out of 30 Dow components -- dividend payers, every last one.

Cisco seems set to break away from these two peers via future dividend increases. The networker powers its payouts with just 29% of its trailing earnings, which is among the lowest payout ratios on the Dow. J&J, in stark contrast, funnels 65% of its earnings into dividend checks. The situation doesn't change much if you look at cash flow instead of earnings: J&J spends a meaty 38% of free cash flow on dividend expenses (the Dow's second-highest ratio), while Cisco slides in at a far more comfortable 21%. It's fair to say that Cisco has more headroom for dividend increases than the medical giant does.

JPMorgan's earnings and cash headroom are even loftier than Cisco's, but the megabank remains under the thumb of government regulation. It may be years before JPMorgan is allowed to increase its payouts in any meaningful way, but Cisco can't seem to stop boosting those dividends. So, out of this Dow trio, Cisco is the dividend booster to watch for the next few years.

There's a downside to this dividend bonanza that doesn't get much press, though. Cisco has scaled back its share repurchase program significantly since it started paying dividends in early 2011. Some might say dividends are superior to buybacks because company leaders are seldom great investors. That being said, you should keep this strategy shift in mind before going all-in on Cisco as a long-term income stock.

CSCO Free Cash Flow TTM Chart
CSCO Free Cash Flow TTM Chart

CSCO Free Cash Flow TTM data by YCharts.

Once a highflying tech darling, Cisco is now on the radar of value-oriented dividend lovers. Get the lowdown on the routing juggernaut in The Motley Fool's premium report. Click here now to get started.

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Fool contributor Anders Bylund holds no position in any company mentioned. Check out Anders' bio and holdings or follow him on Twitter and Google+. The Motley Fool owns shares of Johnson & Johnson, Cisco Systems, and JP Morgan Chase. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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