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Profit From the Correction: Cisco Stock Is a Strong Buy

The valuation of Cisco stock is attractive after its recent selloff

Stocks have been getting pounded for the past month. And with huge volatility every day, it’s hard to trust any rebound at the moment. That said, some investors have been complaining that there are still relatively few bargains within the tech space. By and large, tech companies have held up even as other sectors like energy have imploded. However, the selloff has created some tech bargains. Take Cisco Systems (NASDAQ:CSCO), for example. CSCO stock has plunged from $50 as recently as Feb. 12 to below $35 today.

An Earnings Disappointment Sets Up a Discount for Cisco Stock Investors
Source: Ken Wolter / Shutterstock.com

Cisco stock has fallen 27% in a month; it’s down a startling 41% from its 52-week high. Cisco has sold off for the reasons you’d probably expect. First, the trade war hit demand for its products throughout 2019. Now the coronavirus from China has cast further doubt on the spending plans of Cisco’s major customers. Delays of projects, such as the rollout of 5G systems, are creating short-term obstacles for Cisco. But investors may be overreacting to the company’s problems.

Sluggish Earnings

Cisco released its fiscal second-quarter results on Feb. 12. It was not a particularly cheery report. The company’s earnings per share and revenue did surpass its guidance, but that was largely because the company had set expectations so low. Its operating income only rose 1% year-over-year, while its revenue fell 3.5% YOY.

The company doesn’t expect its business to pick up in the near-term, either. It forecast another single-digit-percentage decline in revenue next quarter. That’s not surprising, given that its key hardware division is continuing to struggle. The company’s comments on its earnings conference call indicated that it is clearly struggling at the moment. After Cisco reported its results, the company announced that it would carry out layoffs to keep its costs in check during this lean period.

Not All Bad News

While Cisco’s earnings didn’t beat analysts’ average estimates by a large amount, there was plenty to like under the surface. For one, its security business grew 9% in Q2 versus Q1. That’s not surprising, as security is booming in general right now, and Cisco has invested heavily in the area. Security also has similarities to Cisco’s areas of expertise, and success in security should help strengthen the company’s competitive edge over the long-term. That said, there’s a ton of firms looking to take share from Cisco in the security sector.

Perhaps most importantly, the revenue of Cisco’s services division rose 5% YOY in Q2. Cisco has long been a hardware vendor, and it’s traditionally focused on making big hardware deals. However, Cisco, like so many other tech companies, has realized that Wall Street really pays a premium for recurring revenues. As a result, Cisco has added more services to its portfolio, and it’s taking payments for some products over longer periods of time.

Obviously, given the company’s share price at the moment, Wall Street isn’t rewarding Cisco for its steady services growth right now. Sooner or later, however, as investors’ sentiment improves, analysts will highlight Cisco’s increasingly strong subscription services and software sales and argue that the company deserves a higher valuation.

Valuation And Dividend

Speaking of value, Cisco stock is downright cheap at this point. Analysts, on average, forecast that Cisco will earn roughly $3.25 per share over the next year. That would put Cisco’s price-earnings ratio at just 12. A skeptic could argue that a P/E ratio of 12 is reasonable, since Cisco is a “dead money” company that hasn’t gone anywhere for years.

Then again, for much of the 2010s, investors labeled Intel (NASDAQ:INTC) and Microsoft (NASDAQ:MSFT) as dead money businesses as well, as both appeared to be stagnant companies living off aging cash cows. For much of the decade, both stocks traded for around 10-12 times their earnings. Then Microsoft pivoted to the cloud, while Intel started developing a ton of next-generation technology that went beyond its bread-and-butter CPU chips. Apple (NASDAQ:AAPL) similarly traded under 15 times its earnings for much of the past few years before suddenly exploding higher as Wall Street warmed up to its services story.

There’s no guarantee that Cisco will catch that sort of big wave going forward. The company will need to develop a narrative that gets investors excited if it wants its stock to start trading at 18 times or 20 times its earnings instead of its present P/E ratio of 12. That said, Cisco’s effort to generate more recurring software and services revenues is a great start. This is the classic formula that tech companies use nowadays to get investors excited. While Cisco’s hardware sales will always be volatile, the recurring revenues make its results less volatile and make the whole operation more valuable.

Cisco’s Strong Dividend

In addition to being a cheap stock, Cisco also offers a robust dividend. Cisco’s stock currently has a dividend yield of 3.6% per year, which means that it offers double the dividend yield of the S&P 500 index as a whole.

On top of that, Cisco is known for its rapid dividend hikes. The company has increased its dividend eight years in a row. Over the past five years, it has increased its dividend at an annualized rate of more than 13% per year. Given the company’s strong profitability, its  dividend payout ratio is just 44% despite its juicy dividend yield. Add it all up, and Cisco is a strong growth and income stock.

The Verdict on CSCO Stock

Cisco is not the most glamorous tech stock out there by any means. Many investors have labeled it “dead money.” But as the past few years have shown, tech companies with low P/E ratios and strong earnings can suddenly spring to life.

Will Cisco enjoy a huge rally over the next year? A lot would need to go right for it for that to happen. It’s still facing major challenges, including the virus, slow network rollouts, and its relatively weak recent earnings report. In general, though, these concerns should lift as we enter the back half of 2020. And at this price, it won’t take much for Cisco stock to rally.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned INTC stock.


Article printed from InvestorPlace Media, https://investorplace.com/2020/03/profit-from-the-correction-cisco-stock-is-a-strong-buy/.

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