Thomas-Soellner/iStock via Getty Images
Thomas-Soellner/iStock via Getty Images
2022 has been a bonanza for blue-chip bargain hunting.
While the broader market has avoided a bear market (unless you count intraday lows) plenty of world-class blue-chips have suffered a lot more.
This creates the opportunity for conservative income investors to buy attractively valued high-yield blue-chips like Cisco (NASDAQ:CSCO ) at prices not seen in years.
So let me show you the four reasons why now is the time to start buying Cisco, the ultimate high-yield tech utility, for your diversified and prudently risk-managed income portfolio.
Here's the bottom line upfront on Cisco.
CSCO's 35% bear market began when it was trading 36% overvalued with a peak PE of 19.5
Its slow but steady tech utility thesis remains firmly intact.
Cisco's Q3 and Outlook Hampered By Supply Chain Challenges" - Morningstar
Cisco's third-quarter revenue was flat year over year, as sales were impacted by the war in Ukraine, COVID-19 lockdowns in China, and the prior year's quarter having an extra week. The company stopped operations in Russia and Belarus in March, which had a 2% impact on growth. Cisco's third-quarter includes April, which had the start of the latest round of lockdowns in China. Not being able to procure and receive components inhibited the final weeks of the quarter and Cisco's outlook." - Morningstar
China is expected to start lifting restrictions in Shanghai on June 1st but supply chain bottlenecks could persist for the rest of the year (assuming unlocking goes to plan).
CSCO has delivered very solid returns in the dividend era and is expected to keep slightly exceeding the market in the future.
If CSCO grows as analysts expect by 2024 it could deliver 30% total returns or 13% annually.
By 2027 if CSCO grows as expected (7% CAGR) and returns to historical fair value, it could deliver 75% total returns or 12% annually.
10 Year Inflation And Risk-Adjusted Expected Return
(Source: Portfolio Visualizer Premium) (Source: Portfolio Visualizer Premium)
CSCO's future returns are expected to be similar to its dividend era returns of 11.3%, or 2.5X inflation-adjusted returns over the last 11 years.
What inflation-adjusted returns do analysts expect in the future?
(Source: DK Research Terminal, FactSet)
Over the next 30 years, CSCO could deliver 12X inflation-adjusted returns.
(Source: DK Research Terminal, FactSet)
CSCO's role in a portfolio is to offer superior and safer yield, slightly long-term outperformance, and minimal fundamental risk.
(Source: DK Automated Investment Decision Tool)
(Source: DK Automated Investment Decision Tool)
For anyone comfortable with its risk profile, CSCO is a potentially attractive low-risk high-yield tech opportunity.
There are many ways to measure safety and quality and I factor in pretty much all of them.
The Dividend Kings' overall quality scores are based on a 253-point model that includes:
Credit default swap medium-term bankruptcy risk data
Short and long-term bankruptcy risk
Accounting and corporate fraud risk
Historical cash flow growth rates
Long-term risk-management scores from MSCI, Morningstar, FactSet, S&P, Reuters'/Refinitiv, and Just Capital
Dividend friendly corporate culture/income dependability
Long-term total returns (a Ben Graham sign of quality)
Analyst consensus long-term return potential
In fact, it includes over 1,000 fundamental metrics including the 12 rating agencies we use to assess fundamental risk.
credit and risk management ratings make up 41% of the DK safety and quality model
dividend/balance sheet/risk ratings make up 82% of the DK safety and quality model
How do we know that our safety and quality model works well?
During the two worst recessions in 75 years, our safety model 87% of blue-chip dividend cuts, the ultimate baptism by fire for any dividend safety model.
How does CSCO score on our comprehensive safety and quality models?
Approximate Dividend Cut Risk In Pandemic Level Recession
10% Margin of Safety For A Potentially Good Buy
What does a 98% quality score mean?
Cisco is the 12th highest quality company on the Master List (98th percentile)
How impressive is this fact?
The DK 500 Master List includes the world's highest quality companies including:
All global aristocrats (such as BTI, ENB, and NVS)
All 13/13 Ultra Swans (as close to perfect quality as exists on Wall Street)
49 of the world's best growth stocks
In other words, even among the world's best companies, CSCO is higher quality than 98% of them.
Cisco was founded in San Jose, California in 1984.
Its specialty is the hardware backbone of the internet and networks.
Recurring revenue is more stable and leads to higher multiples for companies.
We note that Cisco's networking products are typically upgraded every three-to-seven years, and consumers typically keep the existing vendor in place as to not disturb the network. Changing network systems is a massive undertaking due to migrating existing data and infrastructure hardware to a new architecture; any network disturbance can have a tremendous cost. The more critical the application, the higher the reluctance to make a change. Most firms are inherently risk-averse to making enterprise network changes like swapping vendors, especially if the existing network has kept business operations functional. Furthermore, competitors publicly acknowledge the difficulty in taking market share from Cisco's dominance as the incumbent solution. Pricing power is indicated by steady low- to mid-60% gross margins over the last decade even as competitors entered the market." - Morningstar
CSCO is a very boring but beautiful business, offering good solutions to enterprise clients who are highly conservative and risk-averse.
Cisco's shift into selling subscription-based hardware, software, and services as three-, five-, or seven-year packages have further entwined the company within its expansive customer base. New products are sold with this scheme, and Cisco is working on adopting the model to incumbent products. Data analytics and intent-based networking make Cisco stickier with the customer, since losing such valuable software capabilities can be detrimental to business results and network operations. Beyond network operation products, changing to a different security vendor can seem like a risky proposition if threats have been mitigated in the past." - Morningstar
Cisco's plans to become a one-stop solution provider to its clients are going well so far, with most customers trusting it after decades of solid results.
We believe that our revenue performance in the upcoming quarters is less dependent on demand and more dependent on supply availability in this increasingly complex environment. While certain aspects of the current situation are largely out of our control, our teams have been working on several mitigation actions to help alleviate many of the component issues that we've been facing. We believe that we will begin to see the benefits of these actions in the first half of the next fiscal year." - CEO, fiscal Q3 conference call
Cisco is supply-constrained at the moment, with a record backlog of demand it simply can't fill thanks to China's lock-downs.
Recurring revenue is growing at 11%, while sales were flat.
The backlog is up 130% to a record $15 billion.
New orders grew at 8%, indicating healthy overall demand.
Subscription revenue now makes up about 44% of sales and is the fastest-growing part of the business.
New order growth ranged from 4% to 11% in all geographic regions.
CSCO's buyback authorization stands at $17.6 billion after buying back $252 million worth of shares at an average price of $54.2 in Q3 (our Q1).
Now let's take a look at the math backing up CSCO's investment thesis.
(Source: S&P, Moody's)
Rating agencies estimate a 0.58% fundamental risk in buying Cisco today.
CSCO has more cash than debt already and its balance sheet is expected to get slowly but steadily stronger over time.
Debt is falling at double digits, while cash is growing at double digits and cash flows are growing at a modest pace.
Credit default swaps are insurance against bond defaults, and thus represent a real-time bond market estimate of a company's short and medium-term bankruptcy risk.
CSCO's CDS indicating fundamental risk has soared in recent months.
Mainly after China's lockdowns began.
1-year bankruptcy risk has doubled to 0.13%.
The bond market is basically agreeing with rating agencies and analysts that CSCO's investment thesis remains intact.
The GF Score is a ranking system that has been found to be closely correlated to the long-term performances of stocks by backtesting from 2006 to 2021." - Gurufocus
GF Score takes five key aspects into consideration. They are:
CSCO's exceptionally strong 97/100 GF score confirms its excellent fundamentals as well as attractive valuation.
An industry leader in financial strength, profitability, growth, and valuation.
CSCO's profitability is historically within the top 10% of its peers.
Profitability in the last year has been in the top 9% of its peers.
CSCO's profitability is relatively stable over the last 30 years, confirming its wide and stable moat.
CSCO's margins are expected to remain stable or improve slowly over time, up to 34% FCF margins in 2025.
Return on capital is pre-tax profit/operating capital (the money it takes to run the business).
Analysts are expecting ROC to increase modestly by 2025 to 742%.
CSCO's ROC Has Been Rising For Over 25 Years
CSCO's ROC has been rising as its transitions to a software-focused recurring revenue business model.
700% to 800% ROC that's trending higher for decades is a confirmation of a wide and stable moat.
Cisco's growth is tied to the growth of the internet, specifically cloud computing.
CSCO is a capex light business and mature company.
Growth spending is now growing in line with sales, representing about 32% of revenue.
Total growth spending over the next four years is expected to be about $72 billion including $24 billion on R&D.
CSCO is a modestly growing business, generating 5% sales growth outside of the pandemic.
The bottom line is growing slightly faster at 7% for net income and 9% for free cash flow.
CSCO's dividend growth isn't expected to be that impressive, merely a 3% annual growth that the bond market expects to keep up with inflation.
But at a 44% average consensus FCF payout ratio it's a very safe dividend.
CSCO is expected to retain $33 billion in post-dividend free cash flow in the next three years, enough to pay off its debt by 3.5X or buy back up to 18% of its shares at current valuations.
Analysts expect CSCO to front-load its $16 billion in buybacks through 2025 in 2022.
At current valuations, analysts think CSCO could buy back 2.3% of shares each year.
Since CSCO began steady buybacks in 2002, it's averaged a net repurchase rate of 2.8% per year.
At the consensus buyback rate, CSCO could buy back 50% of its stock within the next 30 years.
How accurate are analysts at forecasting CSCO's growth over time?
FAST Graphs, FactSet FAST Graphs, FactSet
Smoothing for outliers analyst margins of error are 5% to the downside and 5% to the upside.
CSCO's historical growth rates over the last 20 years ranged from 0% to 11% and analysts expect future growth to be similar to the last 14 years.
Ignoring the tech bubble, CSCO's market-determined fair value is 13.5X to 14.5X, slightly towards the highest end of that range.
Upside To Fair Value (NOT Including Dividends)
I estimate CSCO is worth about 14.3X earnings and today it trades at 12.3X.
Analyst Median 12-Month Price Target
Discount To Price Target (Not A Fair Value Estimate)
Upside To Price Target (Not Including Dividend)
Upside To Fair Value (Not Including Dividend)
12-Month Median Total Return Price (Including Dividend)
Discount To Total Price Target (Not A Fair Value Estimate)
Discount To Fair Value + 12-Month Dividend
Upside To Price Target ( Including Dividend)
Upside To Fair Value + Dividend
Morningstar's DCF model estimates CSCO to be worth 15.4X earnings (not unreasonable but slightly high by historical standards).
Analysts expect it to trade at 15X in 12 months, generating 25% total returns.
I don't care about 12-month price forecasts, just whether or not the current market of safety sufficiently compensates you for the risk profile.
For anyone comfortable with its risk profile CSCO is a potentially good buy and about 2% away from becoming a potentially strong buy.
There are no risk-free companies and no company is right for everyone. You have to be comfortable with the fundamental risk profile.
How long it takes for a company's investment thesis to break depends on the quality of the company.
Years For The Thesis To Break Entirely
These are my personal rule of thumb for when to sell a stock if the investment thesis has broken.
CSCO is highly unlikely to suffer such catastrophic declines in fundamentals.
How do we quantify, monitor, and track such a complex risk profile? By doing what big institutions do.
AA, Industry Leader, Positive Trend
Exceptional, 10th best in the country
Low-Risk, Very Good Risk-Management, Stable Trend
(Sources: MSCI, Morningstar, FactSet, JustCapital, Reuters, S&P)
Good - Bordering On Very Good
CSCO's risk-management consensus is in the top 6% of the world's highest quality companies and similar to that of such other blue-chips as
The bottom line is that all companies have risks, and CSCO is very good at managing theirs.
When the facts change, I change my mind. What do you do sir?" - John Maynard Keynes
There are no sacred cows at iREIT or Dividend Kings. Wherever the fundamentals lead we always follow. That's the essence of disciplined financial science, the math behind retiring rich and staying rich in retirement.
I'm not a market timer and I'm NOT saying that CSCO is done falling.
No one knows when the market will finally bottom, or if it already has.
Historically Average Bear Market Bottom
(Sources: Ben Carlson, Bank of America, Oxford Economics, Goldman Sachs)
If we avoid recession then we might have already bottomed.
If we don't avoid recession (75% of Fortune 500 CEOs expect a mild recession next year) then we might have a bit more to drop.
If inflation comes down faster than expected, then the Fed has a decent shot at a soft landing.
If inflation stays high then the Fed might have to hike to 4% or even more (Deutsche Bank thinks the Fed will go to 5% to 6%).
Nobody can predict interest rates, the future direction of the economy, or the stock market. Dismiss all such forecasts and concentrate on what's actually happening to the companies in which you've invested." - Peter Lynch
But here's what I can tell you with very high confidence.
No matter what happens with inflation, interest rates, or the economy in 2022 and beyond, Cisco will endure and likely thrive.
This AA-rated company has $14 billion more cash than debt and is generating $14 billion in free cash flow per year.
44% of sales are now recurring revenue, making this tech utility business model relatively recession-resistant.
Cisco suffered a setback in Q1, thanks to supply chain disruptions in China.
But Cisco's demand remains strong, and supply is the issue, not future growth prospects.
Cisco isn't an exciting business, but it's a boring and beautiful one.
It's not a risk-free company, those don't exist. But it's risk management is the stuff of legend, in the top 15% of its peers and in the top 4% of the world's greatest companies.
Cisco isn't a hyper-growth tech legend, and it's not going to make you ungodly rich in the coming decades.
But it can potentially deliver market-beating 13% annual returns over the next three to five years, 50% more than the S&P consensus.
And at just 8.5X cash-adjusted earnings, CSCO is 14% historically undervalued, representing a classic Buffett-style "wonderful company at a fair price".
In fact, for an Ultra SWAN company like this, I consider CSCO's current valuation a wonderful price, making it a potentially good buy and not far from a strong buy.
If you are looking for a very safe 3.5% yield you can rely on to grow every year, no matter what the economy does, consider Cisco.
If you want to earn double-digit returns in the medium and long-term with very low (0.55%) fundamental risk, consider Cisco.
If you're looking to make your own luck on Wall Street, then Cisco is a reasonable and prudent choice.
In a world of high uncertainty and peak fear, there is a lot to love about one of the greatest dividend stocks on earth.
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This article was written by
Adam Galas is a co-founder of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 5,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.
The WMR brands include: (1) The Intelligent REIT Investor (newsletter), (2) The Intelligent Dividend Investor (newsletter), (3) iREIT on Alpha (Seeking Alpha), and (4) The Dividend Kings (Seeking Alpha).
I'm a proud Army veteran and have seven years of experience as an analyst/investment writer for Dividend Kings, iREIT, The Intelligent Dividend Investor, The Motley Fool, Simply Safe Dividends, Seeking Alpha, and the Adam Mesh Trading Group. I'm proud to be one of the founders of The Dividend Kings, joining forces with Brad Thomas, Chuck Carnevale, and other leading income writers to offer the best premium service on Seeking Alpha's Market Place.
My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives.
With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and safe and dependable income streams in all economic and market conditions.
Disclosure: I/we have a beneficial long position in the shares of CSCO either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Dividend Kings owns CSCO in our portfolios.