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Should You Buy Cisco Systems, Inc. (CSCO) Stock? 3 Pros, 3 Cons

CSCO stock has a lot going for it, but don't overlook the negatives before buying it

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It has been an exciting year for Cisco Systems, Inc. (NASDAQ:CSCO) shareholders. The company started to change course following longtime CEO John Chamber’s exit last year. Chuck Robbins took the reins last July, and has refocused the company’s strategy toward the cloud. Robbins has acquired many businesses in that space. 2016 delivered better results for CSCO stock, and 2017 is shaping up nicely, as analysts forecast renewed strength in networking.

Add it all up, and Cisco stock finally got some traction. After trading essentially flat for the past decade, CSCO stock is up 12% in 2016. Can the good times continue heading into next year?

CSCO Stock Cons

Transitional Challenges: Cisco, like many older tech companies, relies on legacy technologies. Older inventions still drive much of CSCO’s profits and cash flow. Consider switching, for example. This segment accounts for almost a third of Cisco’s sales, yet it is declining at a high single-digit rate. Thus, it needs to find a lot of growth in other areas to make up for the steady erosion of its top offering. Bulls can counter this point by showing other segments, such as security, that rose at a double-digit rate. But these gains come from a small starting base, and are often in areas with more aggressive competition.

Cisco is indeed making the right moves with big pushes in cloud, security and services. However, at least for the next couple of years, these appear merely sufficient to offset declines elsewhere, rather than powering the company as a whole to meaningful growth. There are worse positions in the world than sitting on $70 billion in cash while milking cash cow legacy businesses. However, for strong CSCO stock performance in the future, these newer initiatives need to replace the current fading divisions.

Eroding Position Competitively: While Cisco’s longer-term results still seem fairly strong, there are worrying signs. Gross margins, for one. Cisco generated gross margins in excess of 70% in 2003, and traditionally earned high 60s margins last decade. These slipped to the high 50s recently, before rebounding modestly in 2016. Falling margins indicate a slipping competitive position. Other companies are hitting Cisco on pricing and taking away the company’s profitability.

The company’s return on assets has also dropped sharply. It traditionally ran around 14% to 15% prior to the Great Financial Crisis. In recent years, this has fallen into the single digits, and sits at about 9% currently. This reflects the company’s inability to convert profits into new opportunities. Whether this is because the company has cash tied up overseas or simply due to a lack of investment opportunities, it leads to poor returns on CSCO stock. A company that can’t find attractive uses for its cash will struggle to deliver strong returns.

China Risk: Cisco generates almost half of its revenues outside of the U.S. Given President-elect Trump’s threats to target China specifically and trade in general, Cisco is more vulnerable than many to a trade war.

Many of the products that Cisco makes can be copied by cheaper Asian competition. Companies such as Huawei would love to take more market share away from Cisco. And in a scenario where various countries start throwing retaliatory tariffs back at the U.S., it would put Cisco in an unfavorable position. Combine that with the worsening overvalued U.S. dollar issue, and Cisco may have issues internationally.

CSCO Stock Pros

Cash Coming Home: Cisco currently operates with a gigantic cash pile. The company counts more than $70 billion in cash and short-term marketable securities. The vast majority of this is held off-shore to avoid taxation on profits. Should Trump get his way, it appears that there would be a tax break, allowing companies such as Cisco to bring their money back to the U.S.

Given that Cisco’s whole market cap is just $150 billion, it’s clear that having more than $60 billion in newly available cash could unlock real value in CSCO stock. Whether the company uses it to boost the already solid dividend, buy back stock or make acquisitions, any such avenue is likely to produce better results than the current situation.

Relatively Cheap: Cisco stock currently trades around 15x earnings and 13x forward earnings. That compares quite favorably to the tech industry as a whole. Although if you view CSCO as a so-called tech utility — with much less growth — the valuation is about what you’d expect.

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Article printed from InvestorPlace Media,

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