It's Time to Buy This IT Company

Jhumpa 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) is the leader in manufacturing and selling networking equipment. The company sells a diverse array of products, which comprise the hardware that enable data transmission across the Internet and other communication and IT products.  

Currently trading at $18.58, Cisco is an inexpensive stock compared to the other major tech players in the industry. Over the years, Cisco has been growing consistently though at a slower pace but is a profitable company with strong balance sheet fundamentals. At this moment, shares are undervalued and the present time may be a good entry point to invest in the shares of the company. The stock looks attractive due to the company’s impressive operating performance, strong financial health, dividend payout, valuation, and positive outlook.

Price Performance

Cisco experienced a huge expansion in the 1990s following which the stock collapsed after the dot-com crash of 2000. In the last five years the stock price could not cross the previous peak of $33 in 2007 despite its decent performance.

<img height="340" src="/media/images/user_13982/cisco-price_large.png" width="488" />

Operating Performance

Cisco's shows strong earnings growth both in the fourth quarter and throughout 2012. Revenues increased 6.6% year over year to $46.1 billion in 2012. The sales increase was primarily due to the strong performance of Service offerings, new product transitions taking place in Switching and increased demand for Data Center. With regard to profitability, profits grew faster than revenue during fiscal 2012. This was attributable to lower operating expenses as a percentage of revenue driven by the cost reduction. Operating income was 21.9% of total revenue for the fiscal year, increasing 410 bps. The company reported net income of $8.04 billion, increasing 23.9% year over year. In the fiscal year 2012, the return on equity was 16%.

However, the company’s growth has been slowed down in the past 5 years. This can be noticed in the following chart that all key operating metrics including revenue, net income, cash flow from operations, experienced growth in the previous 5 years but at a much slower rate.

<img height="245" src="/media/images/user_13982/cisco-operations_large.png" width="468" />

Robust Balance Sheet

Cisco’s balance sheet is strong and it generates plenty of cash. The total amount of cash and investments is around $48.7 billion. Total assets of the company stand at $91.7 billion and debt is only $16.3 billion. In 2012, the company generated $10.3 billion in free cash flow. The company should not have any trouble in paying its debt and interest obligations in future.

Dividends and Buybacks

Cisco has begun to return cash to shareholders in the form of dividends. It paid out $0.12 dividend per share in 2011 and $0.28 in fiscal 2012. The current dividend yield is 2.93%.

Cisco has become very attentive to shareholders by not only paying an ever-increasing dividend but also by buying back stock at a healthy rate. Share count has decreased by roughly 8% in the past two years. Given the strong cash position of the company and a current free cash flow, it should be safe to expect that dividend will be increased annually.

Strategic Alliance

Cisco recently formed a strategic partnership with EMC and VMware to strengthen its portfolio of cloud computing products and services. The Cisco VMW partnership will benefit both companies in the long run. The partnership will take advantage of VMware cloud infrastructure and Cisco's Data Center Networking and Fabric Computing platforms. The software defined datacenter represents a significant growth opportunity for both the companies.

Low valuation compared to its peers

On valuation basis Cisco looks strong. Its trailing P/E is 12.4, lowest compared to other technology players including Microsoft (NASDAQ: MSFT), International Business Machine (NYSE: IBM), Hewlett-Packard Company (NYSE: HPQ) and Juniper Networks (NYSE: JNPR). Cisco has the second highest number in net profit margin and operating margin, only after Microsoft. Cisco’s EPS is also second highest after Microsoft. IBM's share at $204 is the most expensive amongst the lot while the other firms are trading below $35 per share. Thus, Cisco seems to be a good bet with good operating performance and cheaper valuations.

<img height="124" src="/media/images/user_13982/cisco-chart_1_large.png" width="582" />

Bottom line

Cisco is a well-run company with strong asset base and impressive earnings. It is undervalued but has substantial potential for capital appreciation and an increasing dividend payout. Cisco increased its earnings faster than revenue while lowering expenses and undertaking key partnerships. It has also started to reward shareholders handsomely in the form of buybacks and dividends. Over the next few years, it is anticipated that Cisco will reap the benefits of its current strategies and further expand its business in emerging markets. The cloud market is expected to grow significantly and with networking cloud service, Cisco is in an ideal position to grow in this new era. There should be much more upside potential than downside risk at the present time. For me, Cisco is a buy at the current level for the investors looking to play the tech sector.

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jhumpasarkar has no positions in the stocks mentioned above. The Motley Fool owns shares of International Business Machines and 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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