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Cisco (NASDAQ:CSCO) shares have been on a wild ride in the past twelve months. After skyrocketing from $21 to $26+ earlier this year on very strong operating results, the last two quarterly reports from Cisco have hammered the stock. After the most recent pummeling where shares have fallen from $24 to just over $21 in the past month, investors are left to wonder if Cisco is DOA or of the most recent selloff presents a buying opportunity. The earnings report has been well covered here on SA so I won't dwell on the report itself; this article will focus on Cisco's value as an investment now that it is much cheaper than it was only six months ago.

To begin, I'm going to use a DCF-type model that you can read more about here in order to determine if Cisco shares are still a good value or not.

 

 

 

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

       

Prior Year earnings per share

 

$2.02

$1.98

$2.10

$2.28

$2.47

$2.67

x(1+Forecasted earnings growth)

 

-2.00%

6.10%

8.38%

8.38%

8.38%

8.38%

=Forecasted earnings per share

 

$1.98

$2.10

$2.28

$2.47

$2.67

$2.90

        

Equity Book Value Forecasts

       

Equity book value at beginning of year

 

$11.01

$12.31

$13.68

$15.16

$16.77

$18.52

Earnings per share

 

$1.98

$2.10

$2.28

$2.47

$2.67

$2.90

-Dividends per share

 

$0.68

$0.73

$0.79

$0.86

$0.93

$1.00

=Equity book value at EOY

$11.01

$12.31

$13.68

$15.16

$16.77

$18.52

$20.42

        

Abnormal earnings

       

Equity book value at begin of year

 

$11.01

$12.31

$13.68

$15.16

$16.77

$18.52

x Equity cost of capital

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

=Normal earnings

 

$0.99

$1.11

$1.23

$1.36

$1.51

$1.67

        

Forecasted EPS

 

$1.98

$2.10

$2.28

$2.47

$2.67

$2.90

-Normal earnings

 

$0.99

$1.11

$1.23

$1.36

$1.51

$1.67

=Abnormal earnings

 

$0.99

$0.99

$1.05

$1.10

$1.16

$1.23

        

Valuation

       

Future abnormal earnings

 

$0.99

$0.99

$1.05

$1.10

$1.16

$1.23

x discount factor(0.09)

 

0.917

0.842

0.772

0.708

0.650

0.596

=Abnormal earnings disc to present

 

$0.91

$0.84

$0.81

$0.78

$0.76

$0.73

        

Abnormal earnings in year +6

      

$1.23

Assumed long-term growth rate

      

3.00%

Value of terminal year

      

$20.52

        

Estimated share price

       

Sum of discounted AE over horizon

 

$4.09

     

+PV of terminal year AE

 

$12.24

     

=PV of all AE

 

$16.32

     

+Current equity book value

 

$11.01

     

=Estimated current share price

 

$27.33

     

According to my model Cisco shares currently have a fair value of more than $27, or greater than 28% higher from here. That is a large discrepancy between my model's intrinsic value for Cisco and the market's assessment of Cisco's value so we'll take a look now at why that may be.

First, I believe market sentiment has become horrible with Cisco. After two earnings reports, particularly the last one, that were less than encouraging many market participants have likely moved on from Cisco as the easy money has been made. In addition, comments made on the conference call by John Chambers, who is always good for Cisco short sellers, helped in no small part to ensure the share price decline was swift and brutal. The two reports that Cisco issued along with commentary and guidance from management have caused the market to doubt Cisco's future and thus, the share price has declined commensurately.

In addition to this, analysts are expecting flat to down revenue and earnings this year, a combination no investor wants in their stock. If you want to know the reasons why, the conference call is a good place to start but as I said earlier, the quarter is not what we are focusing on here. We are focused on the value of Cisco shares after the terrible report and with the awful guidance and analyst revisions now priced into shares, we'll take a look at what they are potentially worth.

My model takes into account the analyst average earnings growth rates for the next five years, as seen above. In addition to this, I've forecast eight percent growth per year in the dividend payment and I've used a 9% discount rate. Of course, Cisco shares could see upside if it can beat consensus analyst estimates in the future but we could see further downside as well if it continues to issue guidance like we saw last month. However, with sentiment so negative I believe the risk is more skewed to the upside. In particular, after the huge decline in shares, I think most of the bad news is already priced in. That isn't to say there is no downside risk, because there is, but the violent nature of the selloff suggests to me that it is likely overdone.

In addition to this, Cisco is still trading at only ten times next year's earnings. That is very, very cheap for a company with an enormous net cash position on its balance sheet, very strong, reliable FCF and a terrific dividend that is well above market rates. With all of those characteristics, Cisco shares truly represent a bargain to me. Cisco's nearly $50 billion of cash and equivalents means it will be able to continue its characteristic acquisition binge and its $9 billion in FCF means the cash pile is likely to continue to grow in the future. Finally, the biggest piece for many investors is Cisco's robust dividend. At the current 68 cents per year, shares are now yielding 3.2% and as I said earlier, I think Cisco has room to continue to increase this payout by leaps and bounds for the foreseeable future. And in our low interest rate world, a yield that high will attract some income investors that aren't even necessarily interested in Cisco shares' ability to increase in value.

With Cisco, following some ugly earnings-related selloffs, you've got a best of breed tech titan that is down on its luck. We've seen this exact scenario with Cisco before and I'm confident it will eventually turn out the same way as before; we'll see negative sentiment until Cisco proves the bears wrong and shoots higher again. You must be patient if you are investing in Cisco because it can take a while for the company to right the ship and get investors to believe it has recovered. However, the rewards can be terrific as I think shares are roughly 30% undervalued right now and also pay a great dividend. If you've got the patience, Cisco could be your ticket to a great yield and very nice capital gains.

Source: Cisco: 3.2% Yield And 30% Upside