Cisco Might Pay Dividend

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Cisco (Nasdaq: CSCO) CEO John Chambers said yesterday that the networking giant would probably pay a dividend to investors in the future. This represents a fairly significant tectonic shift for the company, but it said that for the time being most of its major investors preferred a share buyback at current prices.

The insinuation here is that Cisco's big investors believe that the stock is undervalued and that a share repurchase would be a better use of some of the company's $21 billion cash hoard than a simple repayment of dividends. This is not logic that I understand, but I don't have to -- I don't own the shares. Cisco's recent actions suggest that it agrees that the stock is undervalued, having used cash instead of equity in its recent acquisitions.

Cisco shareholders approved a measure in 2001 that authorized the company to repurchase up to $20 billion in shares. Thus far under the program, Cisco has retired more than $8 billion worth, $2 billion of which was repurchased this past quarter. This should reduce the total shares outstanding, so shareholders have a larger piece of the company.

Cisco, though, also has an extremely gracious options program for its employees. As such, these massive buybacks have the effect of only wiping out the dilution, and not really going toward the benefit of the shareholders themselves. Should Cisco go down the same path and pay a dividend as Microsoft (Nasdaq: MSFT) and Intel (Nasdaq: INTC) have elected to do, it could do so without breaking a sweat. It routinely generates more than $400 million in free cash flow each quarter, and has substantial liquid resources (including its stock) that it could pay for a regular dividend without any strain whatsoever.

But as we saw with Microsoft's dividend announcement, there is a belief among a subset of technology investors that a company's initiation of a dividend is tantamount to an admission that it is no longer a "growth company." I hope that Cisco's management does not allow such superficial considerations to affect its determination to make an optimal deployment of its excess capital.

Investors interested in companies paying worthwhile dividends should check out Mathew Emmert's Income Investor. Afree trialis, uh, free.

Bill Mann owns none of the companies mentioned in this story.