After Cisco (NASDAQ:CSCO) announced their quarterly results after the end of the 1st quarter of fiscal 2008 (see conference call transcript), the market sold off Cisco's stock and the stock is still recovering. Juniper Network's stock (NYSE:JNPR) experienced a similar fate, although perhaps not so deeply. It prompts you to try to understand how the market treats these network equipment stocks.
In the case of Cisco, it is worthwhile to take note of what John Chambers said recently in an inaugural address of the C-scape 2007 conference. About 7 and a half minutes into the webcast titled "Collaboration and Productivity" that can be accessed through the Cisco C-Scape 2007 web page, you can hear John say the following that I have transcribed:
... I have no lack of growth opportunities. It's how well can we execute, prioritize, realign ... how do we add talent ... through internal development ... from outside the company ... we are going to take some good business risks on that ... and our margin analysis ... it's been probably every time I have been up here over the last 15, 17 years, people have said, 'John, when will your margins begin to deteriorate?' And, the answer is 'I don't think they will, except by mix issue, in terms of the markets we go into'. Now, that doesn't mean there won't be some point movement on it, and I realize that it is very controversial with all the appropriate caveats. But, it is ability to think about this as an architectural play where it actually gets more complex to make it work well and then make that transparent to ... user. If we are right on that, and we continue to do that well, our margins will be in good shape. ...
In other words, it seems, that it is possible to conceive of businesses that can deliver proper, Cisco-like 65%, gross margins at least in the arena of networked solutions. The other major player in Next Generation Networks, Juniper Networks, is able to deliver above 80% gross margins in recent quarters. A third player in North America, namely Nortel Networks (NT), has only delivered a shade better than 40% gross margin in recent quarters.
Thus, just as irrational exuberance could not really be appreciated by many as it was happening, it is difficult to understand this irrational apathy as well. (Of course, the irrational apathy we are talking about is about a single stock, whereas Alan Greenspan was talking about the 'market' in general). One strategy for investors could be to find their investments among victims of irrational apathy. Cisco stock, I believe, is one such. It is able to deliver good margins, shows signs of being able to deliver in the future, and the stock has been beaten down. Forward P/E ratio is only 15.66.
Businesses conceived without proper attention to margins are best avoided by investors. After all, in the final analysis, the stock price is a function of the money that is earned, and having good margins in the business is a prerequisite for profit.
Disclosure: Author has a long position in CSCO