Cisco (CSCO) is a well-known technology giant that Mr. Market is offering cheaply to willing investors. This first-class company sells at 12 times its trailing-twelve-months earnings and at just 10 times its expected earnings for fiscal 2013 (which ends on July 31st, 2013).
But before we check if Cisco's valuation is indeed cheap enough, let's take a look at the company's moat and financials.
The Cisco brand and customer captivity
The most important strength Cisco has is the excellent worldwide reputation it has among businesses and consumers. Being and perceived as the best provider for networking solutions is the best way to attract new business and customers.
Fortunately, Cisco's brand is thriving around the world. An Interbrand survey ranks it the 14th more valuable brand in the world and 2nd (after IBM (IBM)) in business services. So everything is going fine on that front.
(click to enlarge)(Source: Interbrand.com)
Along with Cisco's excellent reputation comes another great strength, customer switching costs. Cisco's solutions are so deeply embedded into its customers' everyday activities that they won't even consider changing providers due to the risk of disrupting their business. That gives Cisco a loyal customer base and some pricing power over its clients.
Cisco's financials - A shareholders dream
Cisco has (including investments) a net cash position of more than $5.5 per share. Furthermore, the company's $16 billion debt is essentially free since its interest income overweighs its interest expense.
Cisco is also a classic "cash-cow." For fiscal 2012, the company generated $1.92 of free cash flow per share and it is expected to increase that in 2013.
At this point, I'd like to highlight the company's return-to-shareholders policy. This is from Cisco's Q4 2012 earnings call transcript (emphasis added):
Frank A. Calderoni - Executive Vice President and Chief Financial Officer
Going forward we intend to our capital allocation strategy to return a minimum of 50% of our free cash flow annually to dividend and share repurchases while providing sufficient financial flexibility to effectively invest in the business and strategic opportunities.
Given that it pays approximately 30% of its FCF as a dividend, Cisco can dedicate around $0.40 to $0.45 per share for share repurchases. That increases its overall cash-to-shareholders yield close to 5% annually (2% from share buybacks and 2.7% from the dividend).
Valuation - A bargain or a trap?
At its current valuation of just 10 times its fiscal 2013 earnings, Cisco is pretty much expected to stop growing for the next decade. I think this scenario is extremely improbable. Therefore, I believe that the market under-pricing Cisco provides an excellent investment opportunity.
For the next decade or so, I expect Cisco to achieve at least half the EPS growth it had over the last decade and grow at an average 7% to 10% rate. Furthermore, given its stable and predictable revenue (due to its huge competitive advantages), I believe Cisco should trade at least at 15 times its forward earnings.
And if I'm right about that, Cisco's fair value is about $30 per share or 50% higher than its current stock price of $20.85. That's a potential return everyone would like, don't you think?