Bill Maher's show, Real Time, has a segment on New Rules, which often includes witty, sarcastic suggestions to politicians, world leaders, and media personalities. I am always looking for opportunities to make value investments and, when I have a new one, I think I will start calling it a "new rule".
This is partly because my old rules don't really apply anymore. I had a rule for a long time to buy Wal-Mart Stores, Inc. (NYSE:WMT) below $50 a share; it has worked out very well for me, but the opportunities to exercise the rule are gone with the recovering market. I still have a rule to buy Microsoft below $25 a share, but I may never get to apply that rule again.
These rules are helpful because they give an investor some guidance on what to do when there is a sell off. If the rule is developed at a time when market panic is not a factor, it may help produce a sane reaction during one of our frequent "risk off' squalls. So, why is Cisco Systems, Inc. (NASDAQ:CSCO) - which closed Monday at $18.81 - below $19 so compelling that it merits a new rule.
Well, CSCO has moved recently, but it is still in a long-term pattern of immobility. I remember when WMT was stuck in the low 50s; WMT's combination of size and immobility reminded me of the Battleship Missouri when the Navy ran it aground at a pretty good speed and at high tide off Newport News in the 1950s. CSCO has been a little bit of the same story and lots of brokers will tell you to stay away from it. But value has a way of shining through in the end and I think the value case for CSCO is strong.
My EPEE methodology tries to replicate the private market value of publicly traded stocks. It separates the net cash (or net debt) from the enterprise and determines the ratio between the enterprise price and the earnings of the enterprise itself. In the case of CSCO, there has been a large build up of balance sheet cash, but there is also some debt.
I calculate net balance sheet cash by adding cash and investments (total - $48.6 billion) and then making a calculation for accounts receivable. CSCO provides financing for many of its customers and so it carries an amount of accounts receivable vastly in excess of the amount that would be carried by a company not providing such financing. In this sense, it is a bit like Ford Motor Company (NYSE:F) and these receivables really should be viewed as a cash-like financial asset (this may be part of the reason CSCO carries a bit of debt).
I subtracted total accounts payable ($.9 billion) from total accounts receivable ($8.0 billion) to get $7.1 billion, which I determined could be added to other assets in deriving net balance sheet cash. Debt is $16.3 billion and thus net balance sheet cash is $39.5 billion or $7.30 per fully diluted share. Subtracting this number from $18.81, we get an enterprise price(what investors are paying for the enterprise after giving a credit for the cash) of $11.51.
Interest income is almost the same as interest expense for CSCO, so the company's earnings per share are almost exactly equal to the enterprise's earnings per share. The latest estimates are $1.89 for calendar 2012, $1.95 for fiscal 2013(ending on June 30, 2013), and $2.02 for calendar 2013. I use $1.89, which produces an EPEE of 6.1. That's right folks, at the current price level you are paying a little bit more than 6 times current earnings for CSCO the enterprise.
The cash flow numbers are even better because CSCO has a lot of depreciation and generally spends less on plant and equipment than depreciation. Six times earnings is an extraordinarily low level (especially in this interest rate environment) and is a level which makes sense only if one assumes that the business is virtually certain to decline; there is no real evidence that this is the case.
CSCO has been growing, although at a slower pace than the furious expansion it experienced in the 1990s. A lot of the balance sheet cash is overseas and, at current tax rates, repatriation would involve a substantial tax payment. But corporations have a way of solving these problems and some of the cash is probably in the one place (Asia) where business is expanding the most and it may be most needed for expansion purposes.
CSCO has become very attentive to shareholders by paying an ever-increasing dividend and buying back stock at a healthy rate. Share count has decreased by roughly 8% in the past two years. The balance sheet cash virtually guarantees that the dividend will not only not be cut, but will be increased annually.
It is very hard to make the case that there is any fixed income investment that will turn out better for you over the next ten years than CSCO at this point. I think that this is a "back up the truck" situation - in many ways similar to WMT below $50.