For a stock that just a few months ago was considered 'dead money', Cisco (NASDAQ: CSCO), has made a remarkable recovery and is now on many analysts' buy lists. Why should you keep Cisco in your portfolio?
Cisco's Solid Performance
Cisco was one of the hottest tech companies of the nineties, with average annual revenue growth of some 40% to 50% and stock prices that had risen from $0.04 per share in 1990 to $80 per share by March 2000. However, by 2001 Cisco's glory days were seemingly over as share prices fell to $15 and spent the next decade or so hovering at this range (currently the stock is trading at around $23 a share). The problems that beset Cisco during this period included weaker growth as companies reined in their spending on IT infrastructure and intense competition from other companies that made it more difficult for it to gain market share in areas such as data centers and WLAN switches. In addition, Cisco also failed to develop new products that could create new revenue opportunities as it had outsourced these to start-ups who then became innovation powerhouses.
So what caused analysts to change their mind about Cisco? Basically, it was the realization that the company was a solid performer whose stock could be bought at a bargain price. This was recently highlighted by the release of its third quarter results, which were better than expected and easily beat Wall Street's forecasts. Its revenue for the period grew to $12.2 billion, a 5.4% increase over the same period last year and which handily beat Wall Street estimates of $12.18 billion. Profits for the period rose to $2.5 billion or $0.46 per share, an increase of 15% over the $2.17 billion recorded for the same quarter last year. The gains were made despite a very challenging economic environment which saw many companies cut down on their IT spending in favor of new technologies such as the cloud.
The report pointed out that although the company's core switching business saw a year-on-year decline of 2%, many of its other divisions were recording outstanding growth in revenues. For example, its data center division enjoyed 77% growth while its wireless division increased by 27 percent. The revenue growth experienced by these divisions was seen as a sign that the company was actually healthier than most analysts had assumed.
With $47.4 billion in available net cash, Cisco started returning money to its stockholders in the form of stock buybacks and dividends. The company has spent some $3.4 billion over the past twelve months to repurchase shares and $905 million in dividends during the third quarter. Cisco started paying dividends for the first time in 2011, starting at $0.06 per share; at present it pays $0.17, a 183% increase. For the third quarter alone, the company returned some $1.77 billion to its stockholders, $905 million in dividends and $860 million in repurchases.
Cisco's Growth Strategy
With its third quarter net earnings of $2.5 billion, or $0.46 earnings per share, Cisco continued its pattern of generating a positive EPH over the past two years. And there is no reason that this trend should not continue as it has successfully managed to keep its market share in the face of stiff competition. Cisco remains the dominant player in its core business niches, such as Ethernet switch markets, where it controls a 61% share, and the router market, where it has a 68% share. The company was also able to maintain higher margins than its competitors. It has an operating margin of 21.9% and a net income margin of 17.5%, compared with Riverbed Technology (NASDAQ: RVBD).
In addition, Cisco is pursuing a growth strategy that includes heavy spending in research and development as well as acquisitions. It spent some $1.54 billion for R&D in Q3 up from $1.36 billion in the same quarter a year ago. The company also announced that it was acquiring SolveDirect, a privately-held company that offers cloud computing solutions, network security specialist Cognitive Security and Ubiquisys, which produces technologies such as small cells and femtocells that improves the connectivity of mobile networks.
The Bottom Line
With the release of its third quarter report, investors seem to be waking up to the fact that Cisco still has plenty of life in it. Despite past setbacks, Cisco is still the largest company in its market, with a dominant market share and revenues that dwarf those of its competitors. Cisco also has plenty of cash on hand, with some $47.4 billion recorded on its balance sheet, which means that it has plenty of capital that it can invest in maintaining and even growing its market share, as well as making inroads in new markets.
It is also a good time to get into the stock while you can still buy it at relatively low prices. The stock is currently trading at $23.51, which most analysts agree is still undervalued and there is still plenty of room for share prices to grow. Keeping Cisco in your portfolio is a great way to grow the value of your holdings with a stock that is sure to increase in value in the medium-term.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.