Cisco Is On Its Way Back to Growth-Stock Status

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One of the great technology stories of our generation is Cisco Systems (NASDAQ:CSCO), the largest provider of hardware and software solutions in the networking industry. Hardware products include switches, routers, data centers and wireless applications. Security solutions is also an important area for Cisco and includes firewall and other software-defined products. Let’s take a look at the history and the future of CSCO stock.

cisco (CSCO) logo on an office building
Source: Ken Wolter / Shutterstock.com

Unfortunately, Cisco is also known as one of the most prominent victims of the 1999 dot-com bubble, as CSCO stock has never recovered from its early 2000 highs. It hit a high of $81 in March 2000 and a post-dot-com-bubble low of $9.46. It was widely considered to be the Tesla (NASDAQ:TSLA) of its time due to its rapid growth and unlimited potential, but with a stock price valuation that greatly exceeds the reality of that growth and expectations.

The disappointing 20-year history of CSCO stock offers a stern warning for investors and traders that are today buying highly inflated growth stocks that may not grow into its valuation. CSCO stock declined 88% from its peak during the dot-com crash.

Today Is a Different Story

But investing is about looking forward. And it’s about what a company can offer investors in the next three to five years. Cisco has been a low-growth company in recent years due to emerging network architecture and competitive hardware price wars. Hyperscalers and cloud companies usually don’t spend many hundreds of thousands of dollars for routers to connect their giant computer and storage farms. Many large companies are choosing software alternatives as opposed to expensive proprietary gear that has been the core business for Cisco for decades.

The company’s revenue growth has been roughly flat for five years. In other words, revenues in fiscal year 2020 are about what they were in fiscal year 2015. Revenues for the fiscal year ending July 2021 are expected to be flat again. However, the company may see some decent growth after that.

Hybridization Is the Buzzword

A hybrid work environment, meaning both in the office and digitally, has been occurring for many years, but it has been significantly accelerated during the Covid-19 pandemic. Cisco is a leader in that area, with its popular Webex suite of products. Webex has been around since 1995, almost 20 years before Zoom (NASDAQ:ZOOM) came to prominence. Webex offers additional solutions besides its core video-conference capabilities, including its contact center, online event management, report support management and training solutions.

Security is another growth engine for the company that claims to be the “largest enterprise cybersecurity company in the world.” This includes applications such as network security, endpoint protection, cloud edge and application security.

Software in general has been a growing aspect of Cisco’s business. It reached $3.6 billion in revenues in Q2 2021, with about 76% of that sold on a subscription basis. Software now represents about a third of the company’s total revenue base.

Cisco’s Financial Strength

Cisco has traditionally maintained a solid balance sheet. As of fiscal year 2020, CSCO maintained cash balances of $29.4 billion and a net cash balance of $14.8 billion (after subtracting debt). Cisco has been generating about $15 billion in operating cash flow. Furthermore, capital expenditures have been in the $700 million to $900 million range.

The dividend payment takes up $6 billion of that free cash flow. That leaves plenty of money for share buybacks, debt repayment and acquisitions. Share buybacks over the past three fiscal years total $39 billion, much of it done at prices far lower than the stock price today. The current dividend yield is approximately 2.8%.

Is CSCO Stock Trading at a Fair Valuation?

CSCO stock appears cheap based on consensus analyst estimates for the fiscal year ending July 2021. However, that may be very misleading. Most analysts add back stock compensation, which is usually a large amount for the company. It doesn’t make sense to ignore stock comp, as Warren Buffett once famously said:

“If compensation isn’t an expense, what is it? And, if real and recurring expenses don’t belong in the calculation of earnings, where in the world do they belong?”

The fiscal year 2021 consensus earnings-per-share (EPS) estimate is $3.22, and my estimate keeping stock compensation as a real expense is $2.65. That’s a spread of price-to-earnings (P/E) ratios of 19x and 15x. My discounted cash flow calculation, which includes expensing stock compensation, comes out to a value range of $60 to $63 with a 6% EBITDA (earnings before interest, taxes, depreciation and amortization) growth rate.

As software and service revenues grow and the enterprise hardware segment stabilizes from product cycles such as 400G, 5G, WiFi-6 and 400ZR/Optical — Cisco may return to a growth company over the next three to five years.

On the date of publication Tom Kerr did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Kerr, CFA is an experienced investment manager and business writer who has worked in the investment and securities business since 1994.

Tom Kerr has worked in the financial services industry for over 25 years. Currently he is a Senior Portfolio Manager at Rocky Peak Capital Management. Prior to that he was Chief Investment Officer and Director of Research of SGL Investment Advisors, and has served in a number of positions at other finance-related organizations. Mr. Kerr has also been a contributing writer to TheStreet.com, RagingBull.com and InvestorPlace.com. He’s a CFA charterholder and obtained a B.B.A in Finance from Texas Tech University.

 


Article printed from InvestorPlace Media, https://investorplace.com/2021/04/csco-stock-is-on-its-way-back-to-growth-stock-status/.

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