Cisco is a Good Long-term Investment

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

Using standard metrics, Cisco (NASDAQ: CSCO) is undervalued. Its PE is 12.35. In comparison, the Networking & Communication Devices Industry has a PE of 16.4 (Yahoo Finance). One of its biggest rivals, Juniper Networks (NYSE: JNPR) has a PE of 34.13. The discrepancy in value is even greater because Cisco is an industry leader. The company owns 62.1% of the Switching Market, which accounted for $14.5 billion of its total $36.3 billion of revenue for fiscal 2012. This market share number is slightly lower than the previous year of 62.6%. The following table shows Ethernet Switching market shares for Q2 2012 (IDC).

Ethernet Switch Vendors Cisco Hewlett-Packard (NYSE: HPQ) Alcatel-Lucent Huawei Juniper Others
Q2 2012 Market Share (%) 62.1 9.2 3.07 2.85 2.48 20.3

None of Cisco’s competitors are even close.

Looking at its balance sheet, Cisco has a tangible book value per share of $6.10. Tangible book value is the same as book value except it ignores intangible assets (e.g. trademarks, patents, etc which are difficult to value). While many investors focus on PE and future earnings, it is a good idea not to forget about book value. Book value is wealth already accumulated by the company. It is more certain than future earnings because the company already has it.

Looking forward, networking is primed for strong growth. The smartphone and tablet revolution are transforming the modern world. These devices have allowed people in the modern world to maintain access to the internet while on the move. It is truly remarkable. The result for Cisco is twofold. First, mobile devices are increasing internet traffic. In the past, people had to be in front of a laptop or a desktop PC to access the internet. Second, the growth is still in its early stages. The following table shows the smartphone and tablet market growth in Q2.

  Q2 2012 Shipments (millions) Q2 2011 Shipments (millions) Year Over Year Change (%)
Smartphones 154.0 108.3 42.2
Tablets 25.0 15.0 66.2

As shown, the shipments for both markets have a high trajectory. Smartphones are still less than 50% of total mobile phone shipments. In Q2, 406 million mobile phones were shipped worldwide, which means smartphones only accounted for 38% of total mobile phone shipments. IDC states, “IDC expects long-term mobile phone and smartphone shipment demand to grow steadily in 2012 and through the years ahead due to the central role mobile phones play in people’s lives.”

Similarly, the tablet market looks like it will continue growing. Microsoft (NASDAQ: MSFT) Windows 8 will launch on October 26. While the OS has faced criticism due to the learning curve, none of that really matters to Cisco. The main positive for Cisco is that Windows 8 has a touch user interface, which means the new OS is tablet friendly. Microsoft, HP, Dell (NASDAQ: DELL), Samsung, and others are planning on releasing tablets. Windows 8 and Windows RT will have Microsoft Office. Thus, traditional Windows PC users who have never bought a tablet before will have an incentive to buy one. Windows 8 tablets should contribute to the tablet market’s fast growth. Overall, smartphones and tablets should continue to drive increases in internet use and as result drive demand for networking hardware.

In the past twelve months, Cisco has grown its EPS by 27.92% year over year. This gives Cisco a Price/Earnings to Growth (PEG) ratio of 0.44. Legendary investor Peter Lynch wrote in One Up on Wall Street, “The P/E ratio of any company that’s fairly priced will equal its growth rate.” While Cisco’s PEG of 0.44 is not forward looking, the number is way below one and shows that Cisco is undervalued. Even if Cisco’s price doubles, its PEG ratio would double to 0.88, which is still below one.

In addition, Cisco’s rivals HP and Dell are facing a great slowdown in the PC industry. In Q3, Worldwide PC shipments declined by 8.6% year over year. HP’s and Dell’s shipments declined by 16.4% and 14.0% year over year, respectively. This puts pressure on HP and Dell, who rely heavily on PC sales. This should pose as a major distraction to the two companies and divert a lot of their focus away from their networking battle with Cisco. Furthermore, Cisco is outperforming (business wise) its competitors in the tough macroeconomic environment. For example, in the most recent quarter, Juniper reported a decline of 39% in its non-GAAP EPS. In comparison, Cisco increased its non-GAAP EPS by 14% year over year. In addition, Cisco boasts a trailing twelve months net profit margin of 17.46%. In comparison, the Networking & Communication Devices Industry has a net profit margin of 14.7% (Yahoo Finance).

Overall, Cisco is a great long-term investment. Cisco has a PE of 12.35, a dividend yield of 3%, and a PEG of 0.44. Also, its industry faces high demand for the foreseeable future because of rising internet traffic due to mobile devices. The company is dominant, undervalued, and is in the middle of an industry that will be around for a very long time. Cisco is a good long-term investment.

Foolish Bottom Line

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Alvin owns shares of Microsoft. The Motley Fool owns shares of Microsoft. 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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