Alongside the rest of the market, shares of Cisco (NASDAQ:CSCO) traded lower in May as trade tensions across the globe heated up. To be sure, Cisco stock bounced from this selloff in mid-May after the company reported strong third-quarter numbers. Management emphasized on the conference call that the then newly announced 25% tariffs on China imports would have minimal impact.
But those gains in CSCO stock were short lived. By the end of May, shares were trading near their mid-May lows as the global trade situation deteriorated.
In the big picture, this trade-related weakness in Cisco stock is an opportunity. This company is firing on all cylinders right now. It has appropriately adjusted its business model to align with secular growth trends and should benefit from operational tailwinds over the next several years. Meanwhile, management has done an excellent job of mitigating the impact of higher and more widespread tariffs.
Net-net, Cisco stock is presently defined by overstated trade weakness and understated medium to long-term growth potential. That combination ultimately implies that CSCO is a good buy here. Indeed, the fundamentals imply runway for shares to run to $60 by the end of the year.
Cisco Is a Solid Business Managing Trade Conflicts Well
Cisco is a stable growth company with healthy margins and secular tailwinds. These factors should drive significant profit growth over the next several years. At the same time, management has appropriately adjusted the business model to reduce the impact of tariffs. Plus, they have businesses to drive through the choppiness.
Cisco essentially builds the things which power the global internet. But once upon a time, many investors thought that the market was moving past it. Additionally, they thought CSCO wasn’t doing enough to keep up with the internet’s rapidly changing trends. That is no longer true. Over the past several quarters, Cisco has adjusted its infrastructure and security solutions to better align with today’s trends. This includes adaptability toward IoT, cloud, and mobile platforms.
In so doing, Cisco stock has successfully defended its market share in the internet infrastructure and security markets, and materially improved its overall business growth trajectory. IoT, cloud, and mobile trends will likely remain relevant for the foreseeable future. Therefore, Cisco should be able to likewise defend itself over that timeframe. Plus, gross margins are currently stable and improving, while the opex rate is falling thanks to greater scale.
Net result? Profit growth looks good today. It projects to remain healthy over the next several years.
The primary risk to this growth narrative is tariffs. That’s because higher tariff-related costs threaten Cisco’s supply chain. But management said on the conference call that they’ve already taken steps to optimize the supply chain and adjust pricing schemes.
In the big picture, then, Cisco stock looks good here. Growth is promising and stable, and management has mitigated risks.
Cisco Stock Has Runway to $60
From a numbers’ perspective, CSCO stock has runway to $60 by the end of the year.
The math here is simple. The global internet-infrastructure market has grown at a very consistent and stable low single-digit rate for several years. It should maintain that growth trajectory for the foreseeable future. Assuming Cisco can successfully maintain its market leadership, its staring at low single-digit infrastructure-solutions growth over the next several years.
Meanwhile, experts forecast the cybersecurity market as anywhere between a 10% to 15% revenue-growth market over the next several years. Cisco is a big and important player in that segment. Even assuming Cisco loses some market share to newer, more cloud-focused security players, Cisco should still grow its security business at a high-single digit rate over the long term.
Putting those two together, Cisco would likely report mid-single-digit revenue growth over the next few years. I peg the growth rate at somewhere between 3% and 4%. Gross margins should trend higher as the company continues to pivot more towards a subscription model. Opex rates should continue to fall with scale. Buybacks will persist. Thus, roughly 3.5% revenue growth should flow into high single-digit profit growth.
That would put earnings per share around $5.50 by 2025. At that time, given renewed revenue and profit growth, Cisco stock should trade at a market-average multiple. That average is 16-times forward earnings. Based on that metric, a reasonable 2024 price target for CSCO stock is $88.
Discounted back by 8% annually (the yield here is 2%), that equates to a 2019 price target of nearly $60.
Bottom Line on CSCO Stock
All things considered, Cisco stock is undervalued today. The company has solid growth potential through continued internet-infrastructure and security-market expansion. Margins are healthy, and buybacks are big. Meanwhile, management initiatives have mitigated the tariff risk.
Altogether, there’s a lot of good here, and not a lot of bad. Because of that, CSCO stock has runway to hit $60 by the end of 2019.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
