Microsoft and Cisco: Not Buying on the Barron's Bounce

Includes: CSCO, MSFT
by: Dan Carty

For the most part, Cisco (NASDAQ:CSCO) has been a dog over the past 5 years. The growth rate in earnings and revenue has been anemic at best and the stock has performed accordingly. The same could be said for Microsoft (NASDAQ:MSFT) which has become one large bond fund with slow growth.

Taking a look at the numbers for Cisco shows growth in earnings of 15% expected for this year and 16% for next year. Microsoft is expected to grow earnings 13% this year and 16% next year. Meanwhile, even with the rising earnings growth rates, these stocks are still trading at a premium to their respective growth rates.

So why is Barron’s’ talking up these stocks this week? I think this is part of the euphoria that has turned into “buy your favorite large cap tech stock” mania. They cite a solid Cisco product line that has “taken the market by storm” as a reason to buy the stock but one wonders where this story was a few months ago when the stock was at its lowpoint? Has business really improved much since then?

As for MSFT, when it announced the Dutch tender a few months ago, it got walloped by the analyst community for the action. Downgrades up the wazoo followed. With regards to news from Mr. Softy, what good has come from Microsoft besides a delay in Vista and a delay in Sony’s PlayStation (which competes with MSFT’s XBox? Furthermore, the rumors of Dell (NASDAQ:DELL) having sales and production issues probably does not help Microsoft much. Yet, this news has not stopped the crowd by taking both of these names near their 52 week highs.

Over the past few years, Cisco has had trouble at the 24 area and Microsoft has had issues with the 27.50 level – levels at which they both currently site. In each case, both traded back to the lows of the range in the following months and with this fall in price, the negative stories started up again for each company. However, if one looks at these stocks with an alternative perspective, this current challenge of the highs is perhaps different than before.

If one looks at the more intermediate term charts, a different story is developing. First of all, MSFT is finding better participation now than it has in the past three years at the current level using on balance volume and the force model as references. Further, the buying trend is acting better than any previous low over the past 6 years.

As for Cisco, the story is not that bullish, as the buying interest still pales in comparison to this level in the past. Further, the buying trend is weakening and selling trend may almost be overdone to the downside. But if you run the S&P 500 up vs. Cisco, Cisco has lagged dramatically which could lead one to argue that it has some catch-up to do.

As for sentiment, Microsoft has seen more downgrades over the past few months than upgrades so this fact could easily fuel a greater rise in the price in the months ahead as analysts race to reverse their calls. As for CSCO, most of the calls since April have been upgrades and buy initiations. I would estimate that Cisco could get some further buy ratings from the analyst community but probably not anything meaningfully. And if something goes wrong with Cisco on the fundamental end, I bet the sell ratings come out from everywhere as the analysts try to book some profits on the recent rise.

So am I pressing the sell button over and over on both of these names? Not yet. I do not like either to outperform going forward and I think that the breakout crowd is just waiting for both of these names to take out their previous top this range. However, if a breakout does occur in both Cisco and Microsoft, that would leave them both very expensive as a result. Both names would be trading at nearly 1.5x this year growth and have higher multiples than the S&P 500. Sure, based on current numbers, they are trading about at growth and someone could argue that earnings are being understated but the bottom-line remains that if they breakout, they will be overvalued.

Thus, from a risk-reward standpoint, this is more risk than reward. Thus, I would not be a buyer of either of these names at this point.

MSFT vs. CSCO vs. S&P 500 1-yr chart:

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