Cisco Systems (CSCO) traded heavily yesterday in after hours on the news of positive third quarter earnings. Over the past year CSCO has provided investors with stagnant returns, however financially CSCO has become increasingly more attractive. If you were to compute an average P/E for CSCO's industry peers, you would compute a figure close to 14.9x. Considering CSCO's current P/E is 10.91x, it is clear CSCO is trading in the bottom quartile of their five year valuation. In light of this, I decided to take a deeper look into the valuation metrics. Also, after having increased 6.9% in after hours I am sure investors are curious as to where CSCO stands in terms of fair valuation. This article begins with outlining the price targets set by various analysts, then provides a two case scenario modeling the true intrinsic value of CSCO, and concludes with both current and future projections for CSCO's intrinsic value of operations, equity, and price per share.
What Do Analysts Expect?
For comparative purposes I have included a sample of 12 different price targets below (see end of article for sources). After CSCO released third quarter earnings, many analysts were shocked as a result of CSCO's performance. Looking at figure 2 below, you will notice the first four price targets were initiated the same day as their earnings. The average price target for these twelve analysts is approximately $21.83 and the median is $22.
Figure 1: Analysts Price Targets
To determine an estimate for CSCO's intrinsic share value that is both conservative and accurate, I used the corporation valuation model. This model is based on three key underlying assumptions including CSCO's current free cash flows, CSCO's weighted average cost of capital, and the firm-specific growth rate. Two scenarios have been provided below to provide investors with a more realistic idea of what to expect in various stages of growth. Scenario 1 assumes moderate growth and scenario 2 takes into account more aggressive growth. The corporate valuation model works by projecting free cash flows forward and then divides the product of that by the difference between the weighted average cost of the capital and the growth rate. This figure results in the value of operations. To arrive at the intrinsic value of the firm I accounted for short-term investments in operating capital, which you will see below is illustrated in each scenario "Plus: ST Investments".
Figure 2: Corporate Valuation Model
The only difference between scenario one and scenario two is the constant growth rate that is assumed in calculating the value of operations. Please note that the constant growth rate used in each model assumes that is the growth rate for the growth in term of what CSCO's operations are valued at and not the rate at which free cash flow grows from FY 2012 to FY 2013. Taking a look at scenario one on the left you will see I used for FY 2012 and FY 2013 I use constant growth rates of 1% and 1.5% respectively. For FY 2012 I computed an intrinsic value of $27.84 and for FY 2013, $31.97. I prefer scenario one because it is more conservative and assumes less growth, however scenario two has been provided to show investors how altering the growth rates affects the model. Regardless, I strongly feel based on CSCO's value of operations for FY 2012 that the true intrinsic value for CSCO's common equity is approximately $147,554 million. If you take into account CSCO's shares outstanding are 5.3 billion, CSCO's true intrinsic value per share is approximately $27.84.
Third quarter earnings were not only a shock to analysts, but to investors as well. CSCO has been trading at the bottom of their five year valuation for quite some time now and deserves to rebound. In conclusion, CSCO is a strong company and even after the recent spike in market value, CSCO is still clearly trading below fair value according to the corporation valuation model.