I know I should be happy with what's happened to Cisco Systems, Inc. (NASDAQ:CSCO) stock over the last several months. I wrote about the company in August of last year, and suggested that they were generating enough cash to significantly increase their dividend. Since their dividend was $0.32 at the time and has been raised to $0.56 today, apparently management had similar thoughts. Previously the stock was at $16, and today shares trade for more than $21. So why am I frustrated? Honestly, it's because I didn't follow my own advice. I saw the potential in Cisco, wrote about it, and did nothing. I'm also here to tell you, this company's not done.
The 800 lb gorilla still rules the industry Cisco faces serious competition from companies within its field like Juniper Networks, Inc. (NYSE:JNPR). However, Cisco also faces the likes of companies like Hewlett-Packard Company (NYSE:HPQ) and Dell Inc. (NASDAQ:DELL). The latter two, hope that networking sales can generate growth. While Juniper is on much stronger footing than Dell or HP, each of these companies struggles to match the scope and size of Cisco's portfolio of products and services. Dell and HP also have the additional challenge because a large portion of their business is tied to the slower growing PC industry. Dell is said to be in talks to go private, but even if this occurs, Dell would still attempt to steal networking sales from the 800 lb gorilla in the industry.
Better margins lead to better cash flow If you are looking for a stock to hold over the long-term, it helps to search for a category leader. One way to find these category leaders is, by looking at their gross margin. Generally speaking, a company with a higher gross margin is either more efficient, or has pricing power. Either way, investors should benefit and a higher gross margin gives the company a safety net against price competition.
Cisco carries a gross margin of 60.95%. Juniper Networks comes close to Cisco with a gross margin of 60.25%. Unfortunately Dell does not break out their margins for each product segment, but even in the usually high margin services segment, they managed a gross margin of just 35.49% at the end of last year. Hewlett-Packard on the other hand, managed a services margin of just 22.40%, which was actually lower than their overall gross margin of 24.19%. With such a huge lead in gross margin, Cisco in theory should generate more cash flow.
What makes sense in theory also happens in reality. Cisco generates significantly more free cash flow than its competition. I use free cash flow per dollar of sales to compare companies of different sizes. In the current quarter, Cisco generated $0.20 of free cash flow using this measure. None of their competition is even in the same ballpark. Hewlett-Packard generated $0.11 per dollar of sales, Dell generated $0.09, and Juniper only made $0.08. This proves that Cisco management is paying attention to detail, by cutting costs where possible to push more money through to spendable cash.