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Dividend stocks are more difficult to find in the technology sector than in most other segments of the market. The reason is that for many years tech companies were reluctant to offer dividend payouts to shareholders. Instead, they preferred to retain as much cash as possible for growth investments, as technology is a fast-moving industry in which it’s easy to quickly fall behind the competition.
But attitudes are changing. The biggest, most profitable tech companies now have clearly sustainable business models that generate billions of dollars of free cash flow, far in excess of their capital expenditure requirements.
Shareholders who seek high dividend payouts and strong dividend growth rates should take another look at the technology sector, and in particular, at the 3.7% tech stock dividend of Cisco Systems (NASDAQ: CSCO).
Free Cash Flow Sustains Dividend Growth
On Feb. 10, Cisco reported better-than-expected results for its fiscal second quarter. It earned $0.57 per share of profit on $11.8 billion of revenue for the quarter. This exceeded analyst estimates, which projected $0.54 per share of earnings on $11.75 billion of revenue.
Revenue was flat on a year-over-year basis, while earnings per share soared 34% from the same quarter of fiscal 2015. The high level of earnings growth was the result of cost controls, as well as fewer shares outstanding, due to the company’s aggressive stock buyback program.
Cisco offers investors a combination of a high yield, as well as high growth. In February, it increased its dividend by 24% and also announced a new $15 billion stock buyback. The new dividend payout is $1.04 per share, which comes out to a hefty 3.7% yield. The stock trades ex-dividend on April 4.
Strength of Business Model
The reason that Cisco is such a strong dividend growth stock is because it is a major cash flow generator. For example, it generated $6.6 billion of operating cash flow over the first half of fiscal 2016. Its capital expenditures amounted to just $576 million in that time.
Consequently, the company generated $6.1 billion of free cash flow, which represented approximately 25% of revenue in the first half of the fiscal year. That is a very high level of free cash flow generation as a percentage of sales, which is a testament to the strength of Cisco’s business model.
Cisco is seeing especially strong results in the emerging markets. From a geographic perspective, last quarter the company grew revenue by 10% year-over-year in the Asia-Pacific, Japan and China region. This growth helped offset a 3% revenue decline in the Americas.
Cisco enjoys low capital expenditure needs and does not have a high level of debt to worry about. This allows free cash flow to pile up.
The company ended last quarter with $60 billion in cash and short-term investments on its balance sheet, compared with a relatively modest $21 billion in long-term debt and a healthy 35% long-term debt-to-equity ratio.
The Best of Both Worlds
Cisco is a rare example of a company generating enough cash flow to raise its dividend at high rates and simultaneously set aside billions of dollars to buy back its own stock. Its $15 billion stock buyback program represents approximately 10% of its current market capitalization, which should give a boost to future earnings growth.
Going forward, Cisco should have little trouble continuing to raise its dividend thanks to its earnings growth and low payout ratio. Its current-quarter revenue is expected to grow 1%-4%. Longer term, earnings growth will be boosted by its $1.4 billion acquisition of Jasper Technologies in February.
Jasper delivers cloud-based service platforms to enterprises and service providers. The acquisition will meaningfully advance Cisco’s ambitions in the emerging Internet of Things sector, in which all sorts of household devices can be connected and communicate with each other.
As Cisco’s earnings continue to grow, its dividend should grow as well. With a 3.7% dividend ̶ a far higher yield than fellow tech giants Apple (NASDAQ: AAPL) and Microsoft (NASDAQ: MSFT) ̶ and a rock-solid balance sheet with high earnings growth potential, Cisco is a top dividend stock in the tech sector.
For more top dividend stocks that run the gamut of market sectors, click here.
DISCLOSURE: Bob Ciura personally owns shares of Apple (NASDAQ: AAPL).