- Cisco's disappointing earnings report was largely expected.
- Worries about future growth are overdone.
- Cisco is now in high-yield territory at 3.5%.
- Buybacks and net cash position should buoy shares.
Cisco's (CSCO) earnings report last night has sent shares tumbling in the pre-market in what has seemingly become a quarterly excuse for investors to sell. Cisco had very subdued expectations going into the report and even though revenue and EPS were both beats and guidance was in line, shares are selling off anyway. In this article, I'll take a look at what Cisco's report means for the stock over the medium term in the context of earnings and valuation as you can read many other opinions on the nuts and bolts of the quarter itself here on SA. I simply want to update my longer-term view on the stock using the information we received last night in order to see what I think of CSCO shares now.
When I last wrote about Cisco, shares had been pummeled to around $21 on the back of more disappointing earnings reports and worries about future growth. In other words, the story is the same for Cisco that it has been for several quarters now. Investors are worried about where the growth is coming from for Cisco and while I respect that, and I wonder as well, I would argue the stock is cheap enough that it doesn't really matter whether it grows at a fast rate or not. The growth argument seems a bit disjointed to me as a stock with a forward PE of 11 isn't pricing in growth anyway. Thus, where does the "disappointment" come in? How can a stock priced for perpetual low single-digit growth disappoint on growth?
I have written about Cisco several times over the past year or so and every time I do, my DCF model produces an intrinsic value of around $27 (see my article linked above for the most recent DCF valuation). Since nothing has really changed in the way of earnings expectations, that is still true. I won't reprint the DCF model because it is so similar to the last one but I still think Cisco is worth around $27. In fact, it's actually more likely to reach that target, in my view, now that the dividend has been raised and the buyback is retiring shares at a fast pace. Cisco has accepted its fate as a mature, large-cap tech stock and is returning its massive amounts of cash generated every year to shareholders in a big way. For a dividend investor, this is a great situation.
Speaking of the dividend, the 76 cents per share is now good for a robust 3.5% yield based on the current pre-market price of shares. With that, you are getting into high-yield territory and given Cisco's size, net cash position, buybacks and strength of the underlying business, I think that is an overreaction on the market's part in terms of selling the stock down. Even if you don't believe in Cisco's business, shares are cheap enough now at 11 times earnings and a 3.5% yield that dividend investors will want to take a look.
I still think Cisco shares have ~30% upside potential from here and with the increased dividend, you are being paid handsomely to wait. At 3.5%, Cisco's yield is nearly double that of the broader market and Cisco's net cash position and strong buyback program should buoy shares even if future operating results are disappointing to market participants again. In the future, I also think Cisco's financial strength will allow it to continue to raise the dividend such that shares purchased today could have a yield of 5%+ in the medium term. If you are looking for a cheap stock in the large cap tech space, there are scarce better choices than Cisco. Take this opportunity to take advantage of the market's overreaction to an earnings report that was generally expected and pick up some 3.5% yielding shares.