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It is common knowledge that several of Cisco's (CSCO) acquisitions have flopped. But the extent to which these investments were a failure was not known to me until recently when I read an interview of Cisco CEO and Chairman John Chambers in Fortune magazine. Mr. Chambers stated that a third of its acquisitions never work. As an excuse, he added that 90% of all acquisitions in the communications equipment industry fail. But that is no consolation to me as a Cisco shareholder. This, in addition to the company's poor job of returning excess cash to shareholders, has made Cisco a very lousy investment over the last five years. Former presidential candidate and Cisco shareholder Mr. Ralph Nader in an article for Reuters slammed Cisco for its penchant for stock buybacks, which have done nothing to improve the stock price. He like many other investors (including me) made the case for a larger dividend in place of the existing paltry quarterly dividend of 6 cents a share.

Outside of capital management, the company seems to have undergone a course correction during the 2nd half of 2011 focusing on the core business of routing, and realigning the lower margin consumer business division. The company is widely expected to beat expectations when it reports Q2 earnings on February 8, 2012. The stock has also significantly outperformed the broader markets by gaining 28% during the last six months.

In this article, I will compare Cisco with some of competitors and identify the companies best suited for your investment dollars. The companies selected for analysis are:

  1. Cisco Systems, Inc.
  2. Juniper Networks, Inc. (JNPR)
  3. NetGear, Inc. (NTGR)
  4. Hewlett-Packard Company (HPQ)

As always, my analysis included the evaluation of historical growth rates in revenue, net income, and book value, and consistency of historical gross and operating margins. I also looked at the return on invested capital to evaluate how well the companies were using their financial resources to generate returns. Finally, employing a very subjective analysis, I ranked the companies based on the individual criteria. The growth rates, operational characteristics, and my rankings for these parameters are presented below.

Historical Revenue Growth Rates:

10 Year

5 Year

1 Year

Ranking

CSCO

9%

9%

8%

3

JNPR

17%

15%

23%

2

NTGR

17%

15%

31%

1

HPQ

8%

7%

1%

4

Historical Income Growth Rates:

10 Year

5 Year

1 Year

Ranking

CSCO

13%

3%

-16%

3

JNPR

-

12%

428%

2

NTGR

-

8%

467%

1

HPQ

-

3%

-19%

4

Historical Book Value Growth Rates:

10 Year

5 Year

1 Year

Ranking

CSCO

8%

17%

12%

2

JNPR

15%

1%

12%

3

NTGR

-

15%

17%

1

HPQ

2%

6%

6%

4

Future Earnings Growth Projections:

Next Yr

Next 5 Yrs

Ranking

CSCO

9%

7%

3

JNPR

29%

13%

2

NTGR

3%

17%

1

HPQ

10%

4%

4

Gross and Operating Margins:

CompanyGross Margin %Operating Margin %Ranking
Current5 Yr AvgCurrent5 Yr Avg
CSCO6163.5617.221.921
JNPR65.666.8215.83.762
NTGR31.532.5610.38.143
HPQ23.423.927.68.544

Return on Invested Capital:

10 Year

5 Year

TTM

Ranking

CSCO

16%

16%

10%

2

JNPR

2%

2%

7%

4

NTGR

13%

13%

15%

1

HPQ

10%

12%

11%

3

Using the rankings above, I summarized the scores by coming up with a weighted average, with extra emphasis on the future growth rates, margins and ROIC, to come up with an overall ranking. The table that follows presents the summary rankings for the four selected companies.

Company

Symbol

Ranking

Score

Cisco

CSCO

3

1.9

Juniper

JNPR

2

1.7

NetGear

NTGR

1

1.2

Hewlett- Packard

HPQ

4

3.2

As shown in the table above, NetGear appears to be the best company among the four companies analyzed as part of this effort. Cisco and Juniper have a very similar score, while Hewlett-Packard comes in dead last.

An attractive company can be a lousy investment if it is overvalued at the time of purchase. Therefore, the next step was to determine the fair value for these companies. This was done using relative valuation. It should be noted that the P/E estimates were developed using historical analysis of the earnings multiple from the last several. The analysis and results are shown in the table that follows:

Valuation

CSCO

JNPR

NTGR

HPQ

Current Yr Proj EPS

$1.77

$0.98

$2.71

$4.09

EPS Growth Rate

7%

13%

17%

4%

Future EPS (5 Yr)

$2.40

$1.60

$5.08

$ 4.84

Expected P/E

17.2

17.2

19.2

10

Price 5 Yrs Out

41.28

27.48

97.50

48.40

Unlevered Beta

1.87

1.87

1.87

1.22

D/E Ratio

16%

9%

0%

52%

Current Tax Rate

35%

35%

35%

35%

Levered Beta

2.06

1.98

1.87

1.63

Risk Free Rate

2%

2%

2%

2%

Risk Premium

6.00%

6.00%

6.00%

6.00%

Size Premium

-0.36%

0.62%

1.63%

0.97%

Cost of Equity

14.0%

14.5%

14.9%

12.8%

Fair Value

$21.41

$13.97

$48.79

$26.55

Current Price

$19.89

$21.64

$40.00

$28.52

% Overvalued

-8%

35%

-22%

7%

As shown above, NetGear appears to be significantly undervalued at current levels while Juniper is grossly overvalued. Cisco is marginally undervalued at current levels.

Disclaimer: Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision.

Source: How Does Cisco Stack Up Against Its Competitors?