Are there any dividend stocks you are considering buying but want to be sure their dividends are safe before going any further?
Leave a comment at the end of this article with a stock you would like me to evaluate for dividend safety.
This week, I will be taking a look at the dividend safety of technology giant Cisco (CSCO).
My full thesis on Cisco can be seen here, but I will focus primarily on its Dividend Safety Score in this article.
Before analyzing the company’s dividend, let’s quickly recap how Cisco makes money. After all, one of the best pieces of investing advice is to only invest in simple, easy-to-understand businesses.
Cisco has been in business for more than 30 years and is one of the biggest tech companies in the world.
The company’s products (77% of sales) and services (23%) are primarily sold to businesses to help them connect computing devices to networks or computer networks with each other.
Switches and routers are Cisco’s largest product segments and help connect communications devices and manage the flow of data between networks.
Cisco’s reach is global in nature with approximately 40% of revenue generated outside of the Americas.
Cisco’s Dividend Safety
As I noted in my recent analysis of Caterpillar’s dividend, my intention is to never own a company that reduces its dividend payment.
The three dividend portfolios in our newsletter have been successful so far. These portfolios have collectively enjoyed over 60 dividend increases and avoided any dividend cuts since they were started.
Companies usually give off a number of warning signs before they actually cut their dividends.
The companies most likely to cut their dividends usually have some combination of high payout ratios, weak free cash flow generation, declining sales and earnings, weak balance sheets, and no proven commitment to paying and growing dividends over time.
Tracking these key metrics is time-consuming, which is why I created Dividend Safety Scores to help me keep tabs on all of these factors for companies I am interested in.
Our Dividend Safety Score analyzes 25+ years of dividend data and 10+ years of fundamental data to answer the question, “Is the current dividend payment safe?”
We look at factors such as current and historical EPS and free cash flow payout ratios, debt levels, free cash flow generation, industry cyclicality, profitability trends, and more. Cisco’s most important dividend and fundamental data can be seen by clicking here.
A Dividend Safety Score of 50 is average, 75 or higher is considered excellent, and 25 or lower is considered weak.
Most companies that end up cutting their dividends score below 25 for Dividend Safety prior to announcing their dividend reduction.
Kinder Morgan, Potash, BHP Billiton, and ConocoPhillips all scored below 20 for Dividend Safety before announcing their dividend cuts.
Fortunately, dividend investors who own shares of Cisco for income can sleep well at night.
Cisco’s Dividend Safety Score of 87 indicates that the company has one of the safest dividend payments in the market.
Unlike more proven dividend growth stocks, Cisco only started paying dividends in 2011. How can the company score so well for Dividend Safety with such a limited track record?
I’m glad you asked.
Cisco’s strong Dividend Safety Score begins with its healthy payout ratios. Over the last 12 months, Cisco’s dividend has consumed 46% of reported earnings and 38% of free cash flow.
While the company’s payout ratios have meaningfully increased since Cisco began paying dividends (see below), their current level is very safe. Even if Cisco’s earnings were unexpectedly cut in half, the company’s payout ratio would still be below 100%.
And Cisco’s earnings are at very little risk of being chopped in half. The company performed relatively well during the last recession, which also impacts its Dividend Safety Score.
Cisco’s sales fell by 9% in fiscal year 2009, and its free cash flow per share dropped by 14%. Technology spending is certainly correlated with GDP growth, but many of Cisco’s solutions are mission-critical for businesses to continue operating.
In future years, Cisco’s performance during economic downturns could be even stronger. The company is shifting more into recurring software and services revenue, which improves Cisco’s cash flow stability and business forecasting.
To put some perspective behind Cisco’s ongoing mix shift, an analyst from Oppenheimer estimates that Cisco’s recurring revenue has doubled since fiscal year 2008.
Sales growth doesn’t do a company much good if it fails to generate free cash flow. Free cash flow is the money that is leftover after a company has reinvested back into the business to keep it competitive.
Without free cash flow, a company cannot sustainably pay dividends over the long term. As seen below, Cisco’s free cash flow generation has been outstanding.
The company has generated free cash flow each year for more than a decade, and its free cash flow per share has more than doubled since fiscal year 2005. Consistent cash flow generation adds further strength to Cisco’s dividend payment.
So far, we have seen that Cisco’s strong Dividend Safety Score is backed up by the company’s healthy payout ratios, relatively strong performance during the last recession, and consistent free cash flow generation.
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Another major factor influencing dividend safety is financial leverage. Companies will always make their debt and interest payments before declaring dividends.
Businesses with high debt levels can be at greater risk of cutting their dividend if they unexpectedly fall on hard times. During such periods, earnings can be significantly reduced and existing cash must be preserved.
Cisco’s balance sheet is in excellent shape. As seen below, the company has more cash ($63.5 billion) than debt ($24.9 billion) on hand.
If the company paid off all of its debt and only used its remaining cash on hand to pay dividends, it could continue making its dividend payments for more than nine years before needing other funds! It’s hard to find a better balance sheet than Cisco’s.
Finally, it’s always worth reviewing a company’s recent sales and earnings trends to make sure no nasty surprises are brewing.
Cisco’s last quarterly earnings report showed adjusted revenue growth of 3% and a 6% increase in non-GAAP diluted earnings per share.
The company also commented that it was pleased with the progress it was making on its continued transition to more software and subscription revenue.
Unlike some old technology giants (see IBM), Cisco continues to hold its own in an ever-changing world.
By now, it is quite evident that Cisco’s dividend payment is very safe. Management last raised the company’s dividend by 24% earlier this year.
Cisco’s quarterly dividend payout has more than quadrupled since 2011 and continues to have double-digit growth potential.
With a healthy dividend yield of 3.4%, Cisco offers a unique blend of safety and growth.
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Closing Thoughts on Cisco’s Dividend Safety
The technology sector is generally not a great hunting ground for dividends because of its fast pace of change and numerous opportunities for growth, which makes companies less willing to pay out dividends.
However, Cisco is a clear exception because of its large size and mature rate of growth. The company is generating more cash flow than it can profitably reinvest, which allows management to shower higher dividends on shareholders.
Cisco’s dividend payment is extremely safe. While the company’s track record of paying and growing dividends isn’t as long as some of my other favorite dividend stocks, Cisco’s dividend scores very well for safety and growth.
The company’s low payout ratios, consistent free cash flow generation, hoard of cash, mission-critical products, and stable sales and earnings growth all make Cisco a safe bet for dividend growth investors.
What other stocks would you like me to review for Dividend Safety? Leave a comment below with the ticker.
I’m curious about the safety of Compass Minerals (CMP)
CMP is a good one. I actually own it in our Conservative Retirees portfolio, and you can see my full thesis on the company here: http://www.simplysafedividends.com/compass-minerals-cmp-dividend-stock-analysis/
I’ll add it to my list of stocks to review for Dividend Safety.
I would like you thoughts on CALM. I would like to add it to my dividend income portfolio.
CALM is a unique dividend-paying stock. Here is a response I recently sent to another member who asked me about the stock:
CALM’s dividend policy is tricky because the company pays out one-third of its net income each quarter as a dividend. In other words, the dividend amount is unpredictable and ebbs and flows with CALM’s underlying business. While it might appear that you are buying a 4.3% yield today, no one actually knows the total amount of dividends that will be paid over the next 12 months – it depends on what happens with CALM’s net income.
Unfortunately, CALM’s business isn’t very predictable either. Despite the generally stable nature of egg demand, prices fluctuate substantially due to swing in egg supply. CALM’s operating margin has swung between 1% and 25% over the last decade depending on industry conditions. Today, the company is experiencing a sharp decline in sales and earnings as favorable industry conditions reverse. It’s hard to say where the bottom will be and when it will arrive. Usually a sub-10 P/E ratio is too good to be true and/or foreshadows additional headwinds ahead.
At the end of the day, you should decide if CALM’s variable dividend policy and cyclical profit patterns are something you want in your portfolio. The business is otherwise on good financial footing ($390 million in cash vs $26 million debt; consistent free cash flow generator) but can certainly cause some headaches from time to time.
Another excellent article! Please consider a similar piece on Southern Co. and Cummins – two companies likely owned by many of your readers.
I agree that Southern and Cummins are strong candidates to review for dividend safety. I’ll add them to my list!
Ford and General Motors.
We have had a number of requests to analyze Ford. I’ll hit these two companies in the coming weeks. Many spectators have been calling for the auto cycle to end in recent years, but it keeps plugging away.
Do you analyze any Canadian stocks. I was curious about Westjet. WJA on the Toronto Stock Exchange.
I primarily focus on stocks listed on U.S. exchanges, but I’ll be sure to take a look at Westjet if I have capacity. Thanks for the idea!
Chevron and/or Exxon: both are aristocrats, have declining revenue, are writing down assets and have been borrowing as of late.
Chevron and Exxon are both great candidates for a dividend review. I’ll be sure to hit them.
Brian- First thanks for all the great info you provide in one spot!
My inquiry is not for a Safety review of a single stock but your thoughts on a sector. Almost all my stocks have a Safety Score of over 70. But my energy holdings….CVX-21, XOM-55, HP-56, SLB-47…..are worrisome. Sell or hold on for an oil rebound that could be quite some time?
You are very welcome, and thank you for your support! A number of members have requested that I review the safety of big oil, which should cover a number of the stocks you mentioned. Stay tuned, and let me know if you have any questions in the meantime.
Love the info in your newsletter.
Archer Daniels Midland Company
I’m really glad to hear that you are enjoying the newsletter! ADM is a solid dividend stock facing some hard times. I think it’s a great candidate for a Dividend Safety review. Thanks for the idea!
Thanks, Patrick. Ford and GM both seem to be popular candidates. I’ll add Ford to my list.
What about HCP, their have been concerns they might cut their dividend.
HCP is a bit of a hairy one. I took a close look at the company’s dividend in March 2016, which you can see here: http://www.simplysafedividends.com/hcp-dividend-aristocrats/
I’ll give the company’s dividend another look now that we have additional earnings information following my initial report.
Same question as claynir – what to do with big oil? Will they cut? What sustained oil price is necessary to save their dividends?
Thank you for chiming in. I agree that evaluating big oil companies for dividend safety would be quite timely and will add this topic to my list.
Love your newsletter!
I’d like to know your thoughts on Gilead Sciences (GILD) and Lockheed Martin (LMT)
Thank you! I enjoy writing the newsletter and am really glad to hear it has been helpful for you. I have received a number of requests to analyze Gilead and will try to hit the company over the next couple of weeks. I’ll add Lockheed Martin to my list as well. Thanks again for your support!
Same at Patrick, Ford
Thanks, Nelson. I agree Ford would be an interesting one, especially after it’s disappointing quarter.
Another great and informative article….thanks!
You are very welcome, Doug. Thanks for reading!
Hi Brian. Thanks for another great article. What about QCOM? It is in the technology sector but has very high SSD rankings including a Safety score of 95.
You’re welcome! Thanks for reading. I’ll add QCOM to my list. The company sure has been a dividend growth machine since it started making payouts in 2003.
Can you please look at GNTX?
GNTX’s dividend looks really safe (89 Dividend Safety Score) with above-average growth potential (99 Dividend Growth Score). The stock is cyclical and tied to the auto cycle, but it generates excellent free cash flow, maintains a low payout ratio near 30%, and has a rock solid balance sheet ($645 million in cash versus $214 million total debt and $97 million dividends paid last year). Management has also paid uninterrupted dividends since 2003. GNTX’s new products are helping the company generate double-digit sales growth as well and could help it fare better in the next auto downturn as it continues expanding wallet share with customers.
I would really appreciate your thoughts on Americas partners (APU) Brian. Their distribution is very attractive. You and Josh Peters at Morningstar Dividend Investor have 60% my trust in newsletters, and Josh rates APU highly while you do not. Thanks Ron Smith
I agree that APU would be a good one. I’ll add it to my list. Thanks for the suggestion!