Just five years ago the title of this article would have seemed like fiction.
At the time Cisco Systems (NASDAQ: CSCO) had no dividend at all and large cap tech was not known as a sector to chase yield. This has changed after years of strong cash flows, excess cash, and the need to appeal to a different investor class. Cisco, Intel (NASDAQ: INTC) and Microsoft (NASDAQ: MSFT) are the new blue chips of the market and the yields are attractive. Cisco currently leads the three with a yield over 3% but that could be short lived as Microsoft and Intel are expected by analysts to increase dividends to take over the first place slot.
Why Shareholders Don’t Like Cash Hordes
Holding a horde of excess cash can actually hurt the value of the stock. There is some level of cash investors like to see if economic conditions get more challenging or a company needs cash for acquisitions and investments. At some level, which is different for each stock, it is just excess cash. If investors wanted to invest in cash, they would just hold cash. They are buying a stock to get a certain return and idle cash does not generate enough return to meet the threshold for equity risk premiums.
Essentially, investors want a return on that cash in excess of the companies cost of capital or the risk level (WACC) they associate with it. Often the cash is not expected to return anything to shareholders or do so much later. The value of the cash is then discounted back from its return date to the shareholders at the WACC to get the present value. The impact can be substantial.
For example, a company with excess cash of $3 billion that shareholders do not expect to have returned for four years is worth just over $2 billion today at 10% discount rate. So companies that have a horde of cash, often do not see it reflected in their share prices at the present value of that cash.
Big Tech Needs to Keep Returning Cash to Improve Valuations
This is what Cisco, Microsoft, Intel and other big tech firms like Apple have started to realize. They are now returning this cash to shareholders to help unlock value. At some of these companies, including Apple and Microsoft, it took activist investors speaking out to push the board and management to take action.
It is important to note that the location of the cash was a small hurdle for Cisco, Apple, and Microsoft. Much of the excess cash at all three resided outside the U.S. and bring it in to repurchase shares or pay dividends would require the firms to pay tax on the repatriated earrings at the normal corporate rate. This is despite already having paid foreign tax on the earnings. In order to overcome this problem, the companies did take out debt and used the cash positions as collateral to avoid a huge tax bill.
Cisco’s Increasing Payouts
Cisco first introduced a quarterly dividend of $0.06 in March 2011. The dividend accelerated in 2H12 to a quarterly rate of $0.14 and its fiscal 2Q14 dividend was for $0.19. Management decided to return cash to shareholders, as many other tech companies did, through both dividends and share repurchases.
Cisco increased its buyback to $8 billion in the first three quarters of this fiscal year and up from $1.55 billion in the comparable period from last year. Total dividend payments for 1Q14 – 3Q14 were $2.784 billion.
Cisco plans to cut peel the buyback plan back which will leave it with cash to deploy into dividends. The dividend will likely increase further and given FCF and its position, a yield of over 4% is possible based on the current share price at Cisco.
Cisco remains a leader in its space and networking does not appear to be going anywhere. The other big tech names also are in strong positions and have also increased dividends and have more favorable policies on returning cash to shareholders.
The current yields at Intel, Microsoft, and Apple are 2.9%, 2.6%, and just under 2%, respectively. The underlying businesses at all three of these firms and Cisco are stable and have some upside.
Intel has benefitted from improving end market fundamentals in its core semi business. Apple and Microsoft are both looking to accelerate growth. With their stable businesses, these tech giants are very much like the new blue chips. The cash positions, ability to generate income, and steady growth outlooks are all positive. Investors can look for both yield and growth from these stocks, they are no longer just growth names.
John has seven years of experience as an equity analyst following various stocks and sectors. As a senior equity analyst, he received awards from the Wall Street Journal and Financial Times for his writing.