For the past few years, investors in Cisco (CSCO) have experienced a turbulent ride. Year-to-date shares are up just over 5% and price has experienced heightened levels of volatility. In this analysis, I will present the case that the recent pullback in share price since the middle of March represents an excellent buying opportunity. In this article I will not rely on subjective analysis of corporate events but rather on quantitative analysis.
A History of Returns
To quantitatively analyze Cisco from a fundamental standpoint, I have relied heavily on return on assets. Return on assets is the net income of a firm divided by average total assets across an operating cycle. Return on assets is a useful figure in that it shows investors how well the management of an organization uses the firm's assets to generate profits. The simple idea behind the indicator is that it provides a normalization of profits in respect to the assets used to generate profits so that impartial analysis can occur. Cisco has a fairly diversified balance sheet in that the largest category of its assets is "short-term investments" at 41% of total assets. Since CSCO has a diversified balance sheet, we can rely on return on assets as a holistic indicator of overall firm activity. The chart below shows five years of return on assets for Cisco.
In the chart above, five years of return on assets information can be seen. In the bullets below, the major economic periods of Cisco's history will be explored in depth. The table beneath the points shows a summary of the discussion.
- The first period that we will study in this analysis is the fourth quarter of 2008 until the fourth quarter of 2009. During this time period, the global recession was impacting the world economy and Cisco was not sheltered from the storm. Fundamental performance of Cisco declined over the course of this year in that returns decreased significantly. Investors do not like holding shares of organizations that are providing diminishing returns and CSCO's stock declined 11% over this same time period.
- The next significant economic period was the first quarter of 2010 until the third quarter of 2010. During this period, Cisco experienced a brief economic recovery. These three quarters were marked by rising returns on assets as profits climbed. Spotting the economic recovery of Cisco, investors purchased shares driving up prices by around 3% over this year.
- A final period of study, which sets the scene for our investment recommendation, is the fourth quarter of 2010 until the fourth quarter of 2011. During these four quarters, economic performance once again began to decline and investors fled CSCO's shares. Over this year, returns decreased and shares declined by 18%.
The table below shows a summary of these time periods:
It can be seen in the table above that a clear relationship exists between how a firm performs from a fundamental standpoint and its overall stock performance. Historically, as Cisco has experienced diminishing returns, the market has sold CSCO. Conversely, as the firm has bettered itself from an economic standpoint, shares have been purchased. This relationship is logical and has merit in that it has stood the test of a time as a fairly reliable method of investing in the company. It is in the light of this intuitive relationship that I recommend purchasing CSCO.
Since the beginning of 2012, CSCO has experienced a constant economic improvement, as measured by return on assets. The company has bettered itself by increasing profits by over 57% and returns have steadily climbed. Throughout this entire process however, shares have experienced very little price appreciation. In my opinion, this disconnect between fundamental performance and price performance represents an excellent investing opportunity and nimble investors should give serious thought to investing in CSCO. Returns have continuously increased since the beginning of 2012 and it is my belief that the relationship between economic and firm performance, which has been strong over the past five years, will continue to be valid in the future. For this reason, I recommend purchasing CSCO.
Rather than rushing into investment ideas, I believe that investors are best served by utilizing a method of market timing. A method of timing that I have found to be helpful is seasonality. Seasonality is a pattern that tends to occur on a frequent basis. For example, natural gas tends to be more expensive in the summer and winter months and less expensive in the months in between. Cisco is no different in that it has historically followed fairly clear trading patterns in a given year. As can be seen in the table below, for the past 23 years, Cisco has increased in 65% of all May months.
Like all statistical relationships, investors should not blindly trust the results, but rather examine possible fundamental reasons behind the relationship. In the natural gas example previously discussed, a clear fundamental driver is the heightened use of natural gas in power generation in the summer and heating demand in the winter. Even though Cisco is not a commodity like natural gas, it similarly experiences cyclical inflows of investment for logical reasons. Within the stock market, large institutions, which attempt to position themselves to capitalize on industries during certain times of the year, invest in cyclical patterns. Cisco is no different in that historically, these institutions have heightened investment during the month of May. It is on the basis of these historical investing patterns that I recommend purchasing Cisco during this month. History has shown that on average, the price increases by 3.5% during May and investors can potentially position themselves well by purchasing within the month.