Companies with market capitalizations of over $100 billion don't typically generate a lot of excitement among investors because the growth rates have typically slowed down. And normally it's tough for these large companies to continue to generate the profits necessary to take them to the next level. However, one company that appears to be on the right track is Cisco Systems (CSCO). Below are four reasons why investors should consider adding Cisco to their portfolio right now.
Reason No. 1: Fundamentals
Cisco released its latest quarterly report on Feb. 19, 2013, after the market closed. This was for the period ending Jan. 26, 2013. There are a few areas to look at on the statements, but let's start with the balance sheet. If we look back six months to when Cisco's last annual statement was filed, we will find that the company had $16.30 billion in long-term debt. During the past six months, Cisco has actually been able to reduce that by approximately $43 million. At the same time, Cisco increased its short-term investments by approximately $610 million.
Now, if we turn our attention to the income statement, we will again see that Cisco has ramped up its earnings power. For the three months ended Jan. 26, 2013, Cisco generated net sales of $12.1 billion. This was an increase of $571 million from the same period a year ago. This includes increases in both the product and service segments. If we look a little lower on the income statement to net income, we will see that this is where Cisco really shined. Due to improvements in gross margin, the company generated net income of $3.14 billion, compared to just $2.18 billion for the same period a year ago. That is almost a $1 billion increase.
The improvements in the fundamentals also resulted in an increased dividend declaration to shareholders. Cisco paid out $0.14 for this recent quarter, an increase of $0.08 from the same period a year ago, making shareholders very pleased. Clearly, Cisco has made strides in making its fundamentals rock solid. Next, let's take a look at its valuation compared to some of its competitors.
Reason No. 2: Valuation
Two things investors have to like about Cisco are its fairly reasonable valuation and its strong dividend yield. Cisco currently offers investors an 11.77 P/E ratio as well as a 3.3% annual dividend yield. Both of these components make it vastly superior to its competitors. Let's look at a few of Cisco's competitors to get an idea of just how strong Cisco looks.
- Arris Group (ARRS): 35.63 P/E ratio and no dividend
- Aruba Networks (ARUN): 373.79 P/E ratio and no dividend
- Brocade Systems (BRCD): 22.82 P/E ratio and no dividend
- Check Point Software (CHKP): 15.30 P/E ratio and no dividend
- F5 Networks (FFIV): 20.39 P/E ratio and no dividend
- Netgear (NTGR): 12.22 P/E ratio and no dividend
- Riverbed Technology (RVBD): 43.06 P/E ratio and no dividend
So, two things are clear by comparing Cisco to some of its strongest competitors in the networking and communication devices industry. First, dividends are rare, and I think that speaks to the strength of Cisco as a viable business moving forward. Second, Cisco's P/E ratio makes it one of the most attractive - if not the most attractive - investments in this particular space.
Reason No. 3: Stock Performance
It's always nice when strong fundamentals correlate to the actual stock return, as that is what investors ultimately care about. Over the past six months, as the chart below shows, Cisco shareholders have enjoyed a nice ride higher.
Click to enlarge image.
Cisco has generated a return of roughly 13% during the past six months. During the same time, the SPDR S&P 500 (SPY) has only returned about 9%. So, Cisco has outperformed the broader market by about 4% - and let's not forget the 3.3% annual dividend yield that the stock boasts. With an upcoming earnings release due on May 15, I expect even higher returns to come.
Reason No. 4: Analyst Growth Rates
While the past performance for Cisco looks great (both in the actual fundamentals and stock chart), we need to look to the future in an attempt to see what the company needs to do to maintain its impressive run. Last year's earnings came in at $1.85 per share, with revenue coming in at $46.06 billion. Currently, analysts are expecting EPS to come in at $1.99 per share for 2013 and $2.10 for 2014. That would translate to growth rates of 7.6% and 5.5%, respectively. Additionally, revenue is expected to be $48.7 billion for 2013 and $51.39 billion for 2014. That would translate to growth rates of 5.7% and 5.5%, respectively.
Clearly, analysts are expecting a bright future for Cisco - and it could be even better than projected. The high estimate for earnings for 2013 is $2.04 and the high estimate for 2014 is $2.28, so there is a lot of room for Cisco to come in with a positive surprise number. One thing we need to keep in mind is that Cisco was able to vastly improve its gross margin number for the previous quarter, and if it is able to continue that trend going forward, the actual numbers could come in vastly superior to the current projections.
One of my concerns with Cisco is that its core businesses (routers and switches) may have reached its maturity, leaving Cisco in the position of trying to grow the business through acquisitions. Thus far, the company has been successful in pursuing this strategy, but it remains to be seen whether that will continue in the future. One reason I tend to believe it will continue being successful is because it has been able to diversify its businesses in the past. Cisco has successfully diversified into data centers, collaboration, network security, wireless communications, and video services.
Although Cisco is an incredibly large and mature company, I still view it as a solid growth story. The company has strong fundamentals, strong projections for the future, an impressive recent stock performance, and an attractive valuation relative to its peers. The risk of maturity is a real one, but I feel the company will be able to deal with that through a healthy and aggressive acquisition strategy.