Why I'm Betting Cisco Will Rise Above $22/Share Soon

by: Private Trader

At its current price of under $21, Cisco (NASDAQ:CSCO) shares are undervalued. I believe Cisco's shares have a great chance of rising in 2011. So I recently took a position in the company.

On or about November 10, 2010 Cisco disappointed analysts by being off by a penny and/or less than 1% on revenues. I really don't care, except that I need to thank the analysts for spanking Cisco and bringing it to my attention. If Cisco had not missed by a penny or so, I would not have been able to buy it at a discount. For details see here.

Although, at that time, he took a position contrary to my present position, commenter ZagnZig made a very helpful point. He said that Cisco insiders had sold their shares and now that the price was being driven down, they would buy the shares back at a 30% discount. I do not believe that CEO John Chambers "engineered" the 30% discount But now that it is in fact almost 30% below the price it was when it disappointed the market, I do agree that the "smart money" might find it wise to start buying Cisco again.

Additional reasoning is as follows:

Growth story

With a broad internet product base, Cisco is almost "too big to fail". You might not be too familiar with Cisco, but if you are reading this sentence online, it is possible that one of Cisco's products is making that possible. Just like gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) continue to inflate in value, I see the internet continuing to grow and become more important or valuable. If you think the internet is likely to grow, then despite foreseeable turbulence, we can agree that Cisco is likely to grow. For a graphic display of past growth, see this article.

Low risk

What continued internet product and service growth means to me is that buying Cisco's beaten down shares is a relatively low risk proposition. At a price of under $25/share, Cisco has clearly been beaten down for telling analysts it predicts a tougher market than it enjoyed prior to 2007.

Arguably, Cisco was not so much punished for slightly missing analysts forecasts, as much as it was for telling analysts that the past times of "easy money" might not be immediately happening. Let's face it, we're all looking for bargains: This hurts Cisco's and other company's margins.

One must consider that many of Cisco's products and services depend on consumer demand. Consumers (and even some businesses) have been in a pinch because many of them are unemployed, under-employed, or worried about staying employed. Cisco did the right thing by speaking the truth about a tough market for its products and services. It then got hit its biggest one day drop in 16 years. (see here). I'm happy Cisco's management told us what it saw. Now, for 2011 earnings reviews, Cisco has a better chance of under-promising and over-delivering.

Dividend payer

Last but not least, Democrats, and even Republicans, agree that the U.S. economy is not doing as well as we had all hoped. We can argue over how to fix the economy but we must admit that it affects how optimistic folks are about upgrading their routers. In fact, President Obama just agreed to allow dividends to continue to enjoy the favorable treatment that they have enjoyed in the past. This factor bodes well for Cisco investors because Cisco has announced that it will begin paying dividends in 2011.

On top of dividends, a strong argument for Cisco to be valued at $25/share is made here .

Under the radar

If you think that Mr. Nadeem Moulvi is not a reputable enough reviewer, then how about the following the work of John Buckingham? On November 11, 2010, in a Mark Hulbert article titled "Overreaction," Mr. Hulbert describes Mr. Buckingham as "Editor of the Prudent Speculator advisory service, which is in first place for performance over the last 15 years among the 69 services tracked over this period by the Hulbert Financial Digest." (see here).

When it comes to results, Mr. Buckingham and the Prudent Speculator have a reputation that has been independently proven for years. And, so it came of interest to me that a stock that I too had been researching was one also purchased by Mr. Buckingham and the Prudent Speculator. How fortunate for me that the price has stayed low long enough for me to also get in at around the same price.

Amazingly, despite quite a few decent articles promoting Cisco, Cisco has not really caught the market's attention. And I'll admit even I get distracted by exciting prospects such as, for example, rare earth elements. I have a position in Rare Element Resources (NYSEMKT:REE) that made me want to say whee! Wednesday). However, a wise investor diversifies; even boring profits are better than none at all.

Institutional investors

At the beginning of January 2011, Cisco may be a natural pick for institutional, mutual fund, and hedge-fund managers who need to re-allocate their portfolios.

Certain financial managers must balance or re-balance their portfolios with big, safe picks in the technology industry. It's not personal. Some of these same managers may have sold Cisco earlier at $24 - $27/share, and yet might now find it wise to repurchase shares at under $22/share. If they can do that and make around 20% in 2011, they are likely to beat the market. That's what they're paid to do. I hope they do it.

Weak points

A prudent manager should be aware that Cisco has to raise its margins, (see some good criticism of Cisco here).

Yet the company's market shellacking has likely brought this weak point to the attention of Cisco's management.. Regardless, it should be easier for Cisco to see and correct this, and thus regain the favor of the market and analysts, then it would be for another company that is already at the top of the analysts' lists. You simply can't be #1 with the analysts all the time, forever. Also, as I will discuss further during my technical analysis, although it has stayed at the same undervalued price range for months now, Cisco can't be a "bad" stock of only $19 - $21.50 forever.

While picking a name like Google (NASDAQ:GOOG) "sounds cool," a prudent manager will notice that, while it's not necessarily a bad pick, with a PE of 24, its predicted growth comes at a substantially higher risk than that of Cisco. (Another low risk proposition for a portfolio manager might be Intel (NASDAQ:INTC) with a PE of 12, but whose growth, on a 5 or more year chart, appears to have historically underpeformed Cisco's.) Some might describe institutional reallocation as related to the "January Effect," but regardless of how we describe this often annual occurrence, it may have an effect on Cisco's share price soon.

Technical analysis

Last but not least, from a technical perspective, the beginning of the famous teacup formation appears to be forming. While no one can guarantee a teacup exists until it actually exists, for those who don't know a teacup is a "bullish continuation pattern" which indicates a down stock will rise (see here).

The MACD at the bottom of the chart linked to above also shows a bullish turning point on or around December 6, 2010. Even though Cisco dropped .10 to close at $20.25 Wednesday, it is still below both its 50-day moving average ($20.96), and its 200-day moving average ($22.96).

At this time, I am unaware of any recent news that would significantly interrupt Cisco's recent trend of returning to somewhere above its 50-day moving average, and possibly even above its 200-day moving average, which, from a fundamental view point seems unreasonably low. Around, or just above $22/share, seems like a reasonable price for this stock to trade at in the near future.

All these factors are at the start of a New Year. None of any of these factors is a guarantee that Cisco will rise, but the combination is compelling.

Disclosure: I am long REE, CSCO.

Additional disclosure: Do your own due diligence; I have a stake in CSCO (and REE) but my holdings and views can change at any moment.