Investors Should Watch Cisco's Transformation

Mark Cash: Within the networking technology sector, we believe that narrow-moat Cisco warrants investor attention. This stable moat trend company is attractive because of its shareholder return policy, free cash flow generation, and we expect Cisco to be successful in its transformation into a software- and services-focused firm.

Cisco remains the dominant supplier of switches, routers, and other networking gear for IT professionals. The market trend of networking professionals moving workloads to clouds is a threat to networking hardware providers like Cisco. However, the company is focused on high-growth areas of software-defined networking, analytics, wireless, and security solutions.

We believe a key advantage Cisco has is its ability to sell an entire networking solution, whereas competitors can only fulfill certain pieces of the network. A notable example of recent market success can be seen through Cisco experiencing its most successful switching product launch in history with its Catalyst 9000. The product is only sold as a subscription-based model and contains software-defined networking, analytics, and security features. We are encouraged that Cisco is rolling the recurring revenue sales model to more product lines, and that the majority of customers are signing up for the most expensive subscription tier that includes advanced analytics and security.

Lastly, regarding its capital return policy, Cisco remains committed to returning at least 50% of its free cash flow to shareholders in the form of dividends and share repurchases. Our expectation is that Cisco will return between 120% to 140% of its free cash flow to shareholders through fiscal 2020. The forecast is based upon $25.1 billion worth of shares being repurchased over the next 14 to 18 months, and we are forecasting an annual dividend increase.