We’re fast approaching that special time of year when we celebrate the silly things our government spends money on by donating to the cause.
Yes, it’s tax time again.
While everyone has a different view on how much money should be collected and how it should be spent, there is no doubt that taxes incentivize people in different ways.
Most of us spend a little time each spring trying to reduce, or defer, our taxes. Some wealthy people hate paying them so much that they go to extremes and squirrel away their money in dodgy overseas accounts.
But most tax planning techniques pale in comparison to those employed by large corporations. After all, they have the resources to hire phalanxes of accountants, and political donations have a strange way of drawing the government’s attention to issues corporations deem important.
Some companies are so successful at sheltering income that they wind up with bloated balance sheets. It makes them particularly interesting to bargain hunters.
Take Cisco Systems Inc. of San Jose, Calif., as an example. You probably know the company as a large network and communications device maker. After all, it was one of the go-go stocks in the internet bubble of the late 1990s.
Over the years the company has slowly transformed from a high-growth darling into a stock better suited to income investors. While its dividend record is a fairly short one, it has increased payments to shareholders three times since starting them in 2011. Its stock now yields 3.3 per cent, which is significantly better than the paltry 1.9 per cent median yield of stocks in the S&P 500.
Cisco also stacks up well on the earnings front. Its profits have more than fully recovered from the crash of 2009 and analysts expect them to grow by 5 per cent next year and 7 per cent the year after, according to S&P Capital IQ.
More importantly, the company trades at 12 times earnings, which makes it a good value compared to the S&P 500’s median price-to-earnings ratio of 18.
And Cisco is labouring with an issue other companies would like to have. It has too much cash: about $46-billion (U.S.) worth of it. Problem is, about $39-billion of its hoard is stuck in overseas subsidiaries. Moving the money back to the United States to pay a special dividend would trigger a big tax bill.
On the other hand, it can keep the money out of the U.S. and use it to build its foreign operations. In effect, the company has a big incentive to use these funds to grow outside the U.S. rather than reinvesting at home. Such are the unintended consequences of the current U.S. tax code.
Nonetheless, Cisco’s investors can dream of getting a big special dividend at some point in the future. Even if the firm took a 30 per cent haircut on the overseas cash, it would still be sitting on a pile worth $6.43 per share. While some cash is needed for operations, a payout of over $5 per share isn’t out of the question, which would represent almost 25 per cent of its current share price.
With a bit of luck, the U.S. might hold another tax holiday, as it did in 2004, to allow firms to repatriate their cash at a relatively low rate. While I don’t expect this to happen during Barack Obama’s tenure, he won’t be in office forever. It might be smart for the company to wait a few years and hope for a little change in Washington.
Either way, Cisco has attributes patient investors should appreciate, and there is a chance it’ll pay a big special dividend in the future.
With an effective tax rate of 12 per cent over the last year, it’s not only a tempting investment but a lesson in what a bit of judicious tax planning can help to accomplish. Keep that in mind when you’re doing your own return this spring.