Why Cisco Is The Best Value In Large Cap Tech Today

| About: Cisco Systems, (CSCO)
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Cisco Systems (NASDAQ:CSCO) shares have been on a tear since last summer, rising more than 50% since that time. However, the announcement of job cuts and lukewarm guidance this past August has sent shares falling almost 15% from the multi-year highs achieved on strong results and a robust dividend. Investors have sold the stock down on perceived lack of demand from Cisco's enterprise and carrier customers and on CEO Chambers' less-than-robust comments regarding global economic conditions. However, I believe these issues to be transitory and as such, the current price of $23 provides a decent entry point for potential longs. Couple this with strong buyback activity ($1.2 billion last quarter) and a dividend that trumps the 10 year Treasury rate and you've got a very strong candidate for both income and growth investors.

In order to figure out what Cisco shares may be worth in light of the monster run in the past year or so and recent events, I'll use an earnings model you can read about in greater detail here. My inputs and sources are as follows: 1) current dividend, 2) current book value and 3) earnings expectations, all from Yahoo! Finance, 4) dividend growth rate of 5% per annum, 5) perpetual growth rate of 3% and 6) discount rate of 9.5%, all of which are my numbers.

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

Prior year earnings per share

$2.02

$2.11

$2.26

$2.47

$2.69

$2.94

x(1+Forecasted earnings growth)

4.50%

7.10%

9.10%

9.10%

9.10%

9.10%

=Forecasted earnings per share

$2.11

$2.26

$2.47

$2.69

$2.94

$3.20

Equity Book Value Forecasts

Equity book value at beginning of year

$10.97

$12.40

$13.95

$15.66

$17.57

$19.68

Earnings per share

$2.11

$2.26

$2.47

$2.69

$2.94

$3.20

-Dividends per share

$0.68

$0.71

$0.75

$0.79

$0.83

$0.87

=Equity book value at EOY

$10.97

$12.40

$13.95

$15.66

$17.57

$19.68

$22.01

Abnormal earnings

Equity book value at begin of year

$10.97

$12.40

$13.95

$15.66

$17.57

$19.68

x Equity cost of capital

9.50%

9.50%

9.50%

9.50%

9.50%

9.50%

9.50%

=Normal earnings

$1.04

$1.18

$1.33

$1.49

$1.67

$1.87

Forecasted EPS

$2.11

$2.26

$2.47

$2.69

$2.94

$3.20

-Normal earnings

$1.04

$1.18

$1.33

$1.49

$1.67

$1.87

=Abnormal earnings

$1.07

$1.08

$1.14

$1.20

$1.27

$1.33

Valuation

Future abnormal earnings

$1.07

$1.08

$1.14

$1.20

$1.27

$1.33

x discount factor(0.095)

0.913

0.834

0.762

0.696

0.635

0.580

=Abnormal earnings disc to present

$0.98

$0.90

$0.87

$0.84

$0.80

$0.77

Abnormal earnings in year +6

$1.33

Assumed long-term growth rate

3.00%

Value of terminal year

$20.52

Estimated share price

Sum of discounted AE over horizon

$4.39

+PV of terminal year AE

$11.90

=PV of all AE

$16.29

+Current equity book value

$10.97

=Estimated current share price

$27.26

Based on Chambers' comments mentioned above, I'm not certain the company will raise its 17 cent per share per quarter dividend next year. Chambers appears to favor buybacks over dividends but he also noted he's open to a larger dividend. Thus, the dividend could very well be increased by much more than 5% per year but I'm factoring in the possibility that buybacks are favored over dividend increases and that the 17 cent payout may stick around for a while. At any rate, the fair value of shares would be roughly the same if buybacks are chosen over dividend increases but investors would see a higher price instead of a larger cash payout, all else equal.

What's interesting is that even after an enormous run, shares are still quite undervalued given the company's ability to buy back shares and pay a large dividend with ease coupled with moderate earnings growth. Consider that in fiscal 2013 Cisco produced a prodigious $12.9 billion in operating cash flows. Then consider that dividends accounted for only $3.3 billion in cash outflows and you'll see why I am so bullish on Cisco from a financing perspective. This company has enormous latitude to spend on things management finds worthwhile such as acquisitions, buybacks and dividend payments. Back to my point about the dividend, Cisco could literally double its payout and while it would require some tougher choices on the investing front, it could be done without taking on debt, for instance. Most companies don't have this kind of financial flexibility and it is a very attractive trait if you are long.

When you combine the company's current price of $23, which is off materially from highs set during the summer, with steady buybacks that are retiring large amounts of stock and a robust dividend, Cisco possesses a nice blend of income and growth potential. When you consider the enormous amount of cash Cisco produces, which dwarfs its already-robust net income, the company has significant latitude when it comes to financing decisions. This means that management can raise the dividend payout and/or buyback amounts simply by reducing discretionary investing expenditures. And given Chambers' history of cautious guidance that has sunk the stock in prior years, I'm not reading into his comments as indicative of a larger, more concerning falloff in demand. We've seen him do this before and it has always been a buying opportunity; I am confident we will see the same thing this time. Cisco shares possess the rare balance of income and growth potential that many investors seek. With shares paying a nearly 3% dividend, steady buybacks and an attractive entry point at $23, Cisco is one of the best values in large cap tech today.

Disclosure: I am long CSCO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.