Network Companies: 3 Buys And 3 Sells

by: Richard Saintvilus

"Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks."
- Warren Buffett

As much as I have come to value the network equipment manufacturers such as Cisco and Hewlett-Packard I have also come to appreciate that the group at times have contained some of the riskiest investments as well - particularly from the standpoint of fundamentals where one can safely argue that a name such as Juniper (JNPR) is indeed overvalued. But then again, we are talking about the technology sector where metrics that are traditionally used to appraise a stock have often been tossed out the window as several of these names are expected to eventually grow into their valuations. Because of this thinking these stocks tend to be significantly more volatile than the rest of the market by at least 50%.

Before we continue I am not suggesting that this sector is by any means a "leaking boat" as the quote above suggests. But based on some numerous factors I think that it might be time to secure some profits as recent evidence suggests that the market is due for a pullback. That said, there are yet reasons to consider selling a few of these names beyond purely technical grounds. As noted, Juniper sports a P/E of 26 and is yet cheaper than a smaller name like Brocade (BRCD) which currently trades at an outrageous multiple of 33. These factors place the sector's leaders in Cisco (CSCO) and Hewlett-Packard (HPQ) in a much better light as they trade at ratios of 15 and 8 respectively.

For these reasons I have started to become more partial to HP and feel that at any price under $30 the stock is trading at a considerable discount to its true potential. Value investors with the patience of 2-3 years should make a play for the company at current levels as the stock has the potential to reach $40 during that span. It is also worth noting that HP is now in the midst of re-organization as it has recently merged both its printing and computer businesses together to save costs and help bring efficiency to its operation. As with Cisco, HP is well positioned to capitalize in increased network demand from the standpoint of its network advantage with its Converged Infrastructure solution. For as much as I like both Cisco and HP, I have become bearish on a name like F5 (FFIV) for similar reasons - not the least of which is the fact that the stock is chronically expensive.

The stock is by far the most expensive among the group from a valuation standpoint as well as by virtue of its enormous P/E ratio of 43. I just don't see the value at current levels and I tend to think that too much is expected of this company that is not even in the top five within the sector in terms of equipment sales. To its credit however, the company has not yet demonstrated signs that expectations are too high. From a technical perspective, I have to think that once money starts to shift out of technology and into the under-performing sectors its P/E will likely drop to the level of Brocade which would then place the stock at a price of $120 from its current of $135. Yet the opposite holds true for a name like Alcatel-Lucent (ALU).

With the stock trading at $2.47 with a P/E of 4 it is clear that the market does not believe that the company can do enough to compete with more prominent names such as Cisco and Hewlett Packard. If there is an underdog within the sector, ALU fits the description. The question is, can it seize this opportunity? That is really hard to say and if pressed for an answer I would have to say no. But that is not because the company has not been performing better. Although it is hard to tell of late, the IP and optics business for the company is trending higher. Its newest routing platform competes extremely well when compared to similar models from Cisco as well as Juniper. Some experts have suggested that it might, in fact, be slightly better. The company is also seeing an uptick in its wireless segment business, and ALU desperately needs this trend to continue.


If you are a value investor with some appetite for risk this is the sector you want to be in as there is no shortage in that department. I would buy Cisco, Hewlett Packard and Alcatel-Lucent. I would stay away from Juniper, F5 and Brocade due to valuations.

Disclosure: I am long CSCO, HPQ.