Trading Cisco Into Earnings

Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Networking giant Cisco Systems (NASDAQ: CSCO) is set to release earnings after Tuesday’s close on November 13, and while the company is expected to meet estimates, analysts are expecting a pessimistic outlook from company CEO John Chambers. Continued economic weakness in Europe and new threats to Cisco’s technological dominance are primary drivers of the concern that has led to the stock selling off a few percent over the last five days. While I would not be buying shares into the earnings release, if the stock stumbles on the numbers or the outlook, be prepared to recognize the buying opportunity and pull the proverbial trigger.

Earnings Expectations

The earnings figures that Cisco is expected to meet – reasonable since an earnings prediction that the company is expected to miss or beat is flawed by definition – are for earnings per share of $0.46 and $11.79 billion of revenue for the quarter. While an “in line” showing should not be seen as a negative, Mr. Chambers has been actively lowering expectations since last April. He sees reluctance by businesses to spend on IT infrastructure in the tenuous economic landscape, and Chambers sees signs that the environment will deteriorate further before it improves.

Rod Hall, an analyst at JPMorgan, has concerns for the company’s performance in the year ahead: "To be clear, we're not making a call on (fiscal quarter) FQ1'13, but do believe FQ2'13 guidance is likely to disappoint and expect 2013 to be a tough year as macro pressures persist.” Mr. Hall recently lowered his rating on the stock from overweight to neutral. Cisco is generally seen as a leading indicator for global IT spending as a result of its extensive reach and customer base.

The Technological Threat

Mr. Hall also sees burgeoning technologies as a potential threat to Cisco’s business as soon as 2014. Amongst these threats, software defined networking (SDN) is a real concern. In a piece for the Silicon Valley/ San Jose Business Journal, Cromwell Schubarth explains: “The new technology shifts control of networks away from the powerful routers and switches made by Cisco and other big players. Instead, software … does the work.” The idea of the SDN is that as networks become more reliant on software and less reliant on hardware, network maintenance and infrastructure can become both faster and much cheaper.

Competitors like Oracle (NYSE: ORCL) are already diving into this arena. They are using their existing relationships with clients as an effective means to retain business and transition to the new platform. Not to be excluded, Cisco has already established an integral strategic alliance with cloud computing maven VMware (NYSE: VMW). The partnership has created an independent unit whose sole goal is the creation of the software defined data center. If the venture works, which is the expected result from these two firms, it should revamp how networking takes place, re-solidifying Cisco’s place at the top.

The Trade

Investors should not be surprised if the market’s initial reaction to Cisco’s earnings or guidance is negative and takes the stock down on the release. Mr. Chambers is expected to deliver a somber message designed to lower expectations, or at least bring them in line with global macroeconomic realities. Cisco has a long tradition, however, of weathering hard times and coming out stronger than ever. The company is taking the needed steps to keep pushing towards the future and there is no reason to believe it will not meet with the same type of success for which it is known. While I would not buy shares prior to the announcement, any type of big move down should be seen as a buying opportunity and used as a catalyst to acquire shares.

Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Oracle and VMware. Motley Fool newsletter services recommend VMware. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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