Rather than viewing the dividend as a surrender to growth, a growing dividend often indicates what management thinks about future earnings growth.

Cisco Systems (NASDAQ: CSCO) was one of the tech darlings of the 1990’s.  The stock rose 69,230% from its public offering in February of 1990 through 12/31/1999. That equates to a 94% annual return compared to 25.6% for the NASDAQ over the same period.  Then, as though on cue, at the dawn of the 21st century, the stock stalled out, tail-spun into a rapid descent and finally, flat-lined with little hope (or expectation) of robust future earnings growth or stock price outperformance.  From 12/31/1999 through 12/31/ 2011 CSCO generated a total return (which includes price movement and dividend income) of -61.9% or a loss of just over 7% per year.  Compare this to the return of NASDAQ for the same period–a decline of 16.9% or -1.4% per year (again including price and dividends).  When it comes to CSCO and all fallen-angel growth stocks for that matter, investor emotions have run the gamut from love to disappointment to hate and finally, neglect.   So why buy CSCO now?

The company surprised investors in May of this year when management reported better than expected FY Q3 earnings.  The stock rallied dramatically on the news and is up approximately 24% year-to-date through May 31–the bulk of that return coming after the earnings report.  Cisco CEO, John Chambers, normally strikes a conservative tone.  On the May 15th earnings conference call he was surprisingly upbeat about the company’s prospects, “Cisco is executing at a very high level in a slow, but steady economic environment…We are starting to see some good signs in the US and other parts of the world which are encouraging.”   In subsequent interviews Chambers stated that although the pace of technological change is increasing, CSCO has historically taken advantage of change to transform the business and trounce the competition.  “Usually, when things are toughest for us is when we work harder and surprise people.  That’s when they should be betting on us.” That kind of optimism bodes well for future growth.

CSCO management and the board of directors initiated a dividend in 2011 and the quarterly dividend has gone up three-fold since then resulting in an expected yield of 2.8%. (The S&P 500 currently yields 1.3%.)  When rocket-propelled growth stocks mature, the declaration of a dividend is often perceived by investors as a declaration of surrender to future growth opportunities for the company.  But, in fact, often at this point in the company’s growth, the dividend  signals what management and the board think about future earnings growth.  In other words, he dividend is frequently established as a portion of  what management and the board believe is sustainable, long-term earnings power.  John Chambers joined a dignified group of corporate managers when he said as much about a dividend increase in August of 2012:  “We wanted to send a message to shareholders.”

Slowing growth does not have to be a death knell for future stock price performance.  Nor does the initiation of a dividend. The market is full of many companies who have successfully made the transition from growth to value stock and have gone on to generate solid performance.  Coca Cola (NYSE: KO) is one such company.  But let’s consider International Business Machines (NYSE: IBM) another company like CSCO which managed the maturation process but also dealt with the additional burden of shifting technological trends.  After maturing from Nifty-Fifty growth stock darling to mature, old-fashioned computer company, IBM spent a decade in exile just as CSCO did.  But the company transformed its underlying business and eventually earnings growth as well as the stock price accelerated once again.  Another consolidation in the early 2000’s and yet another surge (see the 10 year performance chart for IBM).  Buying great companies for the long-term may not result in year-to-year outperformance but over the long-term, it frequently pays off.

With a price/earnings ratio of 11.5x next year’s earnings which is a discount to competitors’ Qualcomm (NASDAQ: QCOM) and Juniper Networks (NASDAQ: JNPR), a dividend yield double that of the S&P 500 and a company executing extremely well in a difficult global economic environment, CSCO is the kind of long-term investment idea investors should consider owning for the long-term.