Is it Time to Sell Cisco?
Adnan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Cisco (NASDAQ: CSCO) has been on an epic run since November. It all started after the company beat analyst estimates with its F1Q13 financial results. Another major factor in this positive sentiment was the acquisition of Meraki. With this acquisition, Cisco plans to target the mid-market consumers primarily in the developing economies. Cisco is one of the industry’s most successful companies when it comes to driving growth from acquisitions. It has a history of making strategic acquisition that can effectively diversify its maturing business.
Despite the recent improvement in its fundamentals, the consensus estimates have not improved, which indicates that the sell side believes Cisco’s future growth is dependent on the success of its acquisitions. Although I am optimistic about long term growth and consider Cisco a strong buy and hold stock, in the short run and at these levels, there is no more upside to Cisco and the stock will start to decline due to investors taking profit.
I recommend long term investors to buy Cisco and enjoy a healthy 2.8% dividend yield (60% above 10-year note) while they wait for capital appreciation. However, investors in it for the short run should take profits because for now Cisco has peaked.
Cisco Systems is one of the world’s largest information technology based companies. It sells Internet Protocol based services and products to customers all around the globe. The company offers its customers switching, storage, set-top boxes, cable modem products, videoscope software products, headend equipment, workstations, access points, IP phones and servers. In its core business, Cisco competes with giants such as Hewlett-Packard (NYSE: HPQ) and International Business Machine (NYSE: IBM). While IBM is going strong in its enterprise segment, HP is facing falling sales from it enterprise segment.
As the chart below shows, the company has been on an epic run. The stock is currently trading only 4% below its 52 week high. This run has been well supported by an improvement in the top and bottom lines. The improvement in EPS and revenue gives us a clue that this epic run is not based on rumors or expectations but actual fundamentals. The decrease in cash can be blamed on the high number of acquisitions Cisco has undertaken during the last year.
However, if we look at the movement of consensus estimates, they are still pretty stable. This is usually interpreted in two ways:
i) The street is still not accounting for the improvement in fundamentals and is missing a trick.
ii) The street does not see this improvement continuing in the long run and considers that the improvement has already been priced in.
I believe there is a third interpretation and it is more pertinent than the two given above. Cisco’s core businesses (i.e. routers and switches) have reached their maturity; therefore the company is focused on diversifying its core business through acquisitions. This inability to drive growth from the primary business increases overall risk and makes the future growth entirely dependent on the success of its acquisitions. This is why improvement in performance has not driven up the street estimates. That said, Cisco does have a good record of successful diversification. In the recent past the company has successfully diversified into the following five segments:
v) Service provider video
Figure 1: Cisco Fundamentals
Figure 2: Estimates and Price
The stock is currently trading at a P/E of 9.7x and P/S of 2.3x. As the chart below shows, the price has moved up but the multiples are being compressed. This is a very bullish signal because it shows that the upward price trend is not based on changing valuations but rather an improving bottom-line. The sell-side is very bullish on the stock, with 82% analyst having a buy or strong-buy rating. However, the stock is still trading only 7% below its mean sell-side target, leaving very little room for upside.
Figure 3: P/E multiple
equityfinancials has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of International Business Machines.. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!