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Why It’s Time To Play Network Stocks

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

Winston Churchill once said “We can always count on the Americans to do the right thing, after they have exhausted all the other possibilities." Time and time again this has proven true as we’ve seen most recently with the raising of the debt ceiling.

For now, the “Fiscal cliff” is the main overhang causing corporations to ration their spending. As a consequence, companies that rely on enterprise expenditures such as the networking group have taken a brutal beating. But it won’t last.

Eventually, these companies will have no choice but to loosen up their purse strings and start looking for every competitive advantage that money can buy – especially those that are sitting on billions in cash with very little growth. When it happens, here are a few names that stand to benefit.

The Case for Cisco

For this reason I think it is prudent for investors to start positioning themselves for a prolonged recovery among those that service enterprises. The first name that comes to mind is Cisco (NASDAQ: CSCO). Not only has the company been on a shopping spree of late with its cloud-based acquisitions, but Cisco has also been on a winning streak in terms of earnings.

In the company’s most recent quarter, Cisco earned $2.6 billion in net income, or $0.48 per share on revenues of $11.9 billion. Remarkably, not only did this represent 6% revenue growth, but Cisco’s profits surged 11%, which helped the company amass $45 billion in cash.

And equally impressive is that this was the company’s seventh consecutive quarter in which it beat earnings, a trend that I expect will continue going into 2013. As of now, the stock remains one of the cheapest on the market at $19 and has recently received an upgrade to $25.

HP is Too Beaten-Up to Ignore

Beleaguered tech giant Hewlett-Packard (NYSE: HPQ) has been in the news for all of the wrong reasons. But on the other hand, it’s hard to imagine that things can get much worse. I realize that this might be a foolish statement to make.

After all, there were many experts making this proclamation before the $8.8 billion writedown for Autonomy was announced. Nevertheless, I can’t ignore what the stock has done since the Autonomy cat was let out of the bag – HP has been up 23%. It seems investors realize that when it is all said and done, the company is not going to die – not with $11 billion in cash on the books.

Making a play for HP at this point seems tough but it really isn’t. The company has a growing services business and it is still dominant in printing. What’s more, there is considerable support at the $11 mark and although the growth outlook is not very good, it is offset by very little risk. To top it off, I think the stock has bottomed and value investors should ask themselves, if not now, when?

Brocade Deserves a Long Look

Although Brocade (NASDAQ: BRCD) often gets ignored when discussing network enterprise environment, there’s a lot to like about what the company has been able to accomplish. But more importantly, investors should start appreciating the direction the company is trying to go – a strategy that I think will eventually make Brocade a good acquisition target for Cisco and possibly Dell.

The company is in the process of broadening its portfolio of services while lessening its dependency on its storage business. Although I think storage presents an advantage over rivals like F5 and Juniper. On the other hand, Brocade wants to take a slightly different approach toward organization and deployment.

The company’s management understands that networks must be cloud-optimized at every critical point. For this reason Brocade has been heavily investing in ways to improve the end-user experience while allowing companies the benefit of defining application performance.

This enterprise trend has also caught the attention of several rivals as many are not trying to position themselves to lead. From an investment perspective I would be adding shares of Brocade as I think the stock is undervalued on a long term basis and may reward patient investors who are willing to give the company the time it needs to execute its strategy.

There’s Potential in F5

It’s hard to not give F5 (NASDAQ: FFIV) credit for the sort of cloud-based preparation the company has been making. F5 has its act together. Although I think the stock is expensive, I also believe it has more room to rally. But as noted, it all hinges on when corporations are going to start opening up their wallets.

Even though the stock is trading at a P/E of 27, which is a meaningful premium to Cisco and Brocade, F5 has not given investors any reason to think it will not be able to grow into its valuation.  The company believes that cloud computing is essentially an exercise in infrastructure integration.

F5 has what it calls "application and control planes," which allows corporations to extend existing data center control to cloud architectures. This is impressive because it also enforces policies that ensure security, performance and reliability. This sets F5 apart from rivals because these are solutions that are hard to duplicate anywhere else.

So although I don’t normally recommend stocks that trades at a significant premium relative to their peers, on the other hand, there aren’t many companies such as F5 that are as well positioned to outperform. Clearly management has a firm handle on this business and investors who are willing to take a risk here may not be disappointed if holding for 12 - 24 months.

Time to Exit Juniper

I’ve always wanted to like Juniper (NYSE: JNPR), which was once considered the heir apparent to Cisco – except, it has not happened that way. For as great as the company’s product portfolio can potentially be, the execution has not been there.

Juniper’s challenge continues to be trying to finding new ways to grow and create the sort of momentum that inspires tech investors to believe. As it stands, the company has fallen behind the rest of the group and it doesn’t appear as if Juniper is able to keep up in any meaningful way, at least not to the extent it justifies the premium in the stock.

At a P/E of 51 with marginal growth, the stock is just too expensive – there’s just no way to spin it. Plus with increase competition from the likes of Aruba Networks and Palo Alto Networks, Juniper may find it even more difficult to find growth opportunities.

The company is heading in the opposite direction and investors would be wise to stay away – at least until management can demonstrate that the company has a solid plan for the future. On the other hand, should the stock drop by another 20%, I’m willing to reconsider.

Bottom Line

As with the chip stocks, which I talked about earlier this week, there are plenty of money-making opportunities within the networking group, but it requires investors to fully understand what sets these companies apart from the rest.

A few names such as Cisco and F5 have been heavily investing in their future via M&A, while others such as Brocade are doing so well that they continue to be the subject of M&A speculation. In other words, networking has been down, but the group is certainly not out. Well, except for Juniper.

rsaintvilus has no positions in the stocks mentioned above. The Motley Fool owns shares of F5 Networks. Motley Fool newsletter services recommend F5 Networks. 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!

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