So, Cisco faces a dilemma all of us wish we had -- how to spend $21 billion. The correct answer for a corporation is to put the cash where it generates the best return for shareholders. The correct answer for me is to buy a tropical island.
Right now, the best return for shareholders does not come from letting billions sit in a savings account. The huge cash holdings of tech giants like Cisco and Microsoft
So what are the alternatives?
1. Acquire smaller companies.
2. Reinvest in the company through capital expenditures and increased R&D.
3. Repurchase stock.
4. Pay out dividends.
Considering the acquisition binges of the '90s that these companies went on, I suspect that they are leery of acquiring marginal businesses. With Cisco's excess capacity, I doubt capital expenditures would yield an acceptable return, and I presume that R&D activities are fully funded.
So the debate really comes down to whether the company should buy back stock or pay out dividends to its shareholders. The two are not mutually exclusive, but do the shareholders benefit more from a buyback or a dividend?
A major stumbling block for the dividend crowd, of course, is the double taxation of dividends at the corporate and individual levels. Share buybacks delay taxation until the shareholders sell.
However, Cisco has shelled out massive amounts of stock option grants to the employees. So, if shares are repurchased and the price rises, the employees benefit much more than shareholders. Stock options don't pay dividends, so in the event of a dividend payout, the employees suffer (option prices decline as dividends increase). But the holders of common stock would receive cold cash. Although the tax penalty is real, the government still does not have a 100% bracket, so at least some of John Chambers' pocket change will rattle into your couch.
Finally, management needs to consider the company's stock price and probably reserve share buybacks for when the stock is undervalued.
David Nierengarten is a longtime Fool Community member.