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Introduction

Cisco (NASDAQ:CSCO) is likely to grow and outpace expectations going forward. The favorable economic environment, backed by growth in key product segments, along with growth in certain locational demographics keeps me optimistic on Cisco. The company is well on its way to improving its profitability and will continue to leverage its strong international position to win customers on a regular basis.

Qualitative Analysis

Source: Information pertaining to CSCO came from the shareholder annual report, shareholder quarterly report, Schlumberger Investor Presentation, along with YCharts.

The float floats the boat of all boats; let's not forget the favorable economic back drop we are currently working with, with regards to Cisco.

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According to Schlumberger, the worldwide GDP is projected to grow at 3.5% for 2013, and 3.9% for 2014. This impacts Cisco because Cisco is sensitive to economic growth, as electrical engineering products are elastic with an elasticity rating of 1.39. Generally a higher elasticity rating implies that the consumer is sensitive to the price of goods and services sold, and a small decrease in the price of the product could substantially improve the demand for the good. In this instance, the GDP growth will cause the demand curve to shift further right, and by default computer based products and services generally decline in price, so it would be wise to anticipate sustained demand growth from a purely economic standpoint over the next several years.

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Cisco's primary areas of growth is the Data Center (65% YOY growth), Wireless (27% YOY growth), and Service Provider Video (20% YOY Growth).

  • The Data Center is referred to as server access virtualization. The Unified Computing System unites computing, network, storage access, along with virtualization into a centrally managed automated system.
  • The Wireless includes wireless access points, controllers, antennas, and integrated management. Its primary target market is business networks and attempts to solve business related networking problems.
  • The Service Provider Video is a division of Cisco that basically offers electronic set-top boxes which basically enables service providers to deliver cable and satellite programming to TV's.

The company's primary growth segments balances out Cisco's legacy businesses (NGN Routing, Security, and Collaboration). This implies that Cisco is effective at identifying and exploiting new market opportunities as old cash cows become dogs. This is an important trait of all technology companies, for a technology company that cannot continue to innovate will falter against the competition. In this instance, Cisco is not at any foreseeable risk of being negatively impacted by the competitive landscape.

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The Americas and the Asian Pacific-Japan-China division is off-setting the negative revenue growth from the European-Middle East-Africa division. This implies that while macro concerns exist, it is likely that those concerns will be mitigated as times goes on. This is based on the GDP forecast from earlier in the article, which illustrated that the European economy is projected to generate 0% economic growth in 2013, and in 2014 the European economy is projected to grow at around 0.5-1%. This implies that the bleeding on the income statement is temporary, and so as long as Cisco does not lose its competitive position in its market segments, Cisco's profitability in the European division will improve over the next three years.

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Cisco's operating margin has shown consistent improvement between Q4 2011 and Q1 2013. Assuming favorable economic projections hold true, the company's profitability is likely to remain in a respectable range of 20-25%. The underlying economics is important because the products and services Cisco offers are highly elastic which affects the pricing power the company has in its respectable markets. I believe that Cisco's profitability will continue to stay above its 4-year average rate of change (the linear trend line).

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The cash from operations has seen consistent improvement, the business is generating cash from operations near its 10-year average. Implying that Cisco's cash from operations is starting to stabilize despite the negative affect the great recession has had on Cisco's business. The improving economic outlook keeps me optimistic on the future cash flows of the business.

Altogether the favorable economic environment, along with the strong portfolio of businesses keeps me optimistic on the company going forward. Cisco's presence continues to grow in Asia, which is counter-balancing the negatives from Europe's economy. This should keep investors on the Cisco bandwagon for many years to come.

Technical Analysis

Some look at Cisco's stock price and recite that the company has lost a decade. The company's stock performance has been pretty abysmal over the past 5-years. Despite all the negativity surrounding the valuation of the stock and its performance relative to the market average, I believe that the stock will be able to sustain a long-term up-trend over next the several years.

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Source: Chart from freestockcharts.com

The stock is trading above the 20-, 50-, and 200- Day Moving Averages. The stock has broken the upper trend line of the descending triangle. The stock will appreciate over the long-term, and is in the beginning stages of a multi-year up-trend.

Notable support is $14.00, $16.00, and $19.50 per share. Notable resistance is $23.00, $27.15, and $33.30 per share.

Street Assessment

Analysts on a consensus basis have reasonable expectations for the company going forward.

Growth Est

CSCO

Industry

Sector

S&P 500

Current Qtr.

2.10%

N/A

N/A

10.80%

Next Qtr.

8.50%

N/A

992.60%

16.30%

This Year

7.60%

4.00%

13.30%

8.10%

Next Year

6.00%

36.30%

33.00%

12.90%

Past 5 Years (per annum)

6.82%

N/A

N/A

N/A

Next 5 Years (per annum)

8.40%

14.09%

17.52%

8.93%

Price/Earnings (avg. for comparison categories)

10.97

0.58

7

21.21

PEG Ratio (avg. for comparison categories)

1.31

-2.08

1.48

2.48

Source: Table and data from Yahoo Finance

Analysts on a consensus basis have a 5-year average growth rate forecast of 8.40% (based on the above table). This growth rate is below the industry average for the next 5-years (14.09%).

Earnings History

12-Apr

12-Jul

12-Oct

13-Jan

EPS Est

0.47

0.46

0.46

0.48

EPS Actual

0.48

0.47

0.48

0.51

Difference

0.01

0.01

0.02

0.03

Surprise %

2.10%

2.20%

4.30%

6.30%

Source: Table and data from Yahoo Finance

The average surprise percentage is 3.7% above analyst forecast earnings over the past four quarters (based on the above table).

Forecast and History

Year

Basic EPS

P/E Multiple

2003

$ 0.33

74.24

2004

$ 1.04

29.17

2005

$ 1.87

23.79

2006

$ 3.14

18.56

2007

$ 4.36

21

2008

$ 4.54

8.78

2009

$ 2.62

23.75

2010

$ 3.41

23.72

2011

$ 3.70

18.11

2012

$ 4.13

16.71

Source: Data from YCharts

The EPS figure shows that throughout the 2003- 2006 period, the company was able to grow earnings. Throughout 2007-2009 earnings were range bound. The flattening in earnings was due to the great recession. Following the recession, in 2012 the company was able to grow earnings to new all-time highs.

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Source: Data from YCharts

By observing the chart we can conclude that the business is somewhat cyclical and is affected by macroeconomics. Therefore, one of the largest risk factors to CSCO is the slowing of international gross domestic product growth. So as long as the global economy continues to grow, the company will generate reasonable returns over a 5-year time span based on the forecast below.

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By 2018 I anticipate the company will generate $2.90 in earnings per share. This is because of product growth, improving global outlook, cost management and continued development overseas.

The forecast is proprietary, and below is a non-linear chart indicating the price of the stock over the next 5-years.

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Below is a price chart incorporating the past 10 years and the next 6 years, detailing 16 years in pricing based on my forecast and price history on December 31st of each year.

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Source: Data from YCharts and price history is from Yahoo Finance.

Investment Strategy

CSCO currently trades at $21.83. I have a price forecast of $30.23 for December 31st 2013. The stock is currently trading below valuation, and should be bought at pull backs as a part of a longer-term accumulation strategy.

Short Term

Over the next twelve to twenty-four months, the stock is likely to appreciate from $21.83 to $30.23 per share. This implies 38.5% upside from current levels. The technical analysis indicates a long-term up-trend. While the previously mentioned price forecast using fundamental analysis further supports the assessment.

Investors should buy CSCO at $21.83 and sell at $30.23 in order to pocket short-term gains of 38.5% between 2013 and 2014.

Long Term

The company is an exceptional investment for the long-term. I anticipate CSCO to deliver upon the price and earnings forecast despite the risk factors (competition, regulation, economic environment). CSCO's primary upside catalyst is international expansion, product development, share buy-backs, and cost management. I anticipate the company will deliver upon my forecasted price target of $52.83 by 2018. This implies a return of 162.88% (including dividends) by 2018. This is a great return for a technology stock.

Year

Dividend Yield @ $21.83 per share

Cumulative Total

2012

2.57

2.57

2013

2.79

2.79

2014

3.04

5.83

2015

3.30

9.13

2016

3.59

12.72

2017

3.90

16.62

2018

4.24

20.87

A higher yielding investment opportunity-- albeit having higher risk-- is to buy the Jan 17, 2015 calls at the $22.00 strike. The call premiums trade at $2.46. The price forecast for the end of 2014 is $38.30. The rate of return if the calls expire at $38.30 is 562.60%, the option will break-even when the stock trades at $22.46.

The risk-to-reward on the option is compelling. The risk however is somewhat high (1.2 beta).

CSCO has a market capitalization of $116.4 billion; the added liquidity makes this an investment opportunity appropriate for larger institutions that require added liquidity.

Conclusion

The dance is not over at the Cisco disco. The good folks in San Jose are on a roll, and it keeps getting better. The conclusion is simple: Buy Cisco.

Source: Cisco To The Disco: The Music Is Not Dead Yet