Cisco Systems reported a terrific quarter last Tuesday with solid and visible growth (see conference call transcript), yet the shares have fallen from the $28 level to $26. The company endorsed 15-16% growth for the July 31st fourth quarter, putting its revenues at the $9.3 billion level for the July quarter. So why did the stock fall in spite of the good news and the rosy outlook?
Cisco was one of the great success stories of the 1990's. Not only did the company "wire" the networking world, but shareholders made a fortune during the decade. Cisco at one point hit a market capitalization of $500 billion. Quarter to quarter revenues were measured in double-digit percentages sequentially as its customer base was spending freely. Cisco became a global player, as well as the global leader in networking gear. Acquisitions came easily and were never dilutive to earnings as Cisco's price-earnings multiple was lofty and could absorb the acquired companies seamlessly.
In recent years, the law of large numbers came into play. Cisco is now looking at nearly $40 billion of revenues the next four quarters. Double-digit percentage revenue gains are now measured year-over-year versus sequential quarters. The company generates operating margins in the high 20's% and has a distribution system second-to-none. But the stock will now trade with a gravity-pull on the price earnings multiple. Cisco's operating margins, brand value and growth rate can support a PE in the low to mid 20's, but not 30 times anymore. Thirty plus multiples are reserved for hyper-growth companies, usually smaller in size as a smaller revenue/earnings base is technically easier to grow at 30% rates.
Last week, the fast money crowd thought the earnings number and the forward guidance were going to be bigger and better. They were wrong, as Cisco guided to solid growth but not the "old-fashioned" growth rates. The fast money took their money off the table very quickly and the shares fell a couple of dollars. I think the stock is a buy here at $26. My price target for the next 12 months is $35, which represents a better than 30% return.
A return of 30% is a very good return for a year's worth of waiting -- the old Cisco gave 30% returns in three months... aah, the old days....The stock is a buy strictly based on strong operating margins and international growth, especially in the emerging markets--including India.
CSCO 1-yr chart