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Cisco: Out Of The Penalty Box


  • Now that CSCO has returned to top-line growth, I am ready and willing to continue to build my position.
  • However, the stock's recent run-up has pushed the company above my fair value estimate and I'm waiting for weakness to add.
  • I'd like to buy CSCO at ~$39/share; however, if my price target isn't hit, I'm more than happy to sit back and watch my existing position flourish.

Back in November I wrote a piece in response to Cisco's (NASDAQ:CSCO) Q1 earnings, wondering whether or not this company was destined to be the next IBM (IBM) in terms of a consistently slumping top-line. I've been long CSCO for years and although many view this stock as a lumbering legacy tech company, it's been one of my better performers. I'm up over 85% on the position that I began building in late 2013. My cost basis is $23.80 and my yield on cost is 4.87%. Even with such success in mind, CSCO was placed in the penalty box for me due to growth concerns. I've never considered selling my shares; I still view this as a strong dividend growth company, but I wasn't willing to begin adding again until top-line growth returned after a streak of 8 consecutive quarters of negative growth. Well, that streak is over, Cisco is out of time out, and I'm hoping to add to my position on the next bit of weakness that CSCO shares experience.

For years now, Cisco has acted like many of the other large cap, "old tech" names. What I mean is, while experiencing a stagnating top-line, CSCO has used the massive cash flows from its high margin legacy businesses to return capital to shareholders (and consequently, financially engineer bottom line growth due to a vastly reduced share count). This is especially the case since 2014, as you will see in the graph below. What's more, CSCO has increased its long-term debt load, which wasn't exactly an irresponsible thing to do in a low rate environment with so much cash locked up overseas; however, it still weakens the balance sheet.

With that said, when you look at the chart below, while the sales and debt trajectories may be concerning, the shareholder return metrics

This article was written by

Nicholas Ward profile picture

Nicholas Ward is a Senior Investment Analyst with Wide Moat Research and the former editor-in-chief and portfolio manager at The Intelligent Dividend Investor, The Dividend Growth Club, and The Income Minded Millennial.

Nicholas is a contributor to the investing group The Dividend Kings where he shares analysis on dividend growth stocks. The Dividend Kings is a group of analysts, led by Dividend Sensei, that teach members how to invest more wisely in dividend stocks. The focus is on helping investors safeguard and grow their money in all market conditions through the highest-quality dividend investments. Features include: 13 model portfolios, buy ideas, company research reports, and a thriving chat community for readers looking to learn how to invest more intelligently in dividend stocks. Learn More.

Analyst’s Disclosure: I am/we are long CSCO, IBM, MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (31)

ryanmartin8 profile picture
Holding at ~$26 cost basis and will purchase more at $35. Thanks for the article.
Nicholas Ward profile picture
Seems like we're of somewhat similiar mindsets; I'd be happy to add at $35 as well - I typically like to average down in 10% increments, so if I bought at $39 the mid $30's would be my next entry point.
Dale Roberts profile picture
Nicholas, you could bought this when you owned it at $35, when you thought it was broken several months ago. Now you think it's fixed in short order and you like it, but now it's too "expensive".

No one knows Nicholas. Not even the experts who know the space intimately. They might make an educated guess. But I'm not sure that the educated guess is much more useful than uneducated guess. There's too much creative destruction.

The tech space can be important for those who seek growth. One would simply have to buy enough of 'em.

Obviously individual guesswork is not very useful and it can tie investors into knots.

Dale Roberts profile picture
I hold a little tech basket found by way of the Dividend Achievers list and 2 simple picks, all done without any further financial evaluation.

Over the last 3 plus years, my tech basket beats the S&P 500 by 8% annual, and it beats the Nasdaq 100 by almost 3% annual.

I do not do any financial evaluation as that would be fruitless, more than silly. What is a short term report or two going to tell me about the business performance of a tech company over a 5 year, 10 year and 20 years history? Well nothing of course.

Zucks profile picture
I stopped reading when you said it was only recently they improved their business. They started maybe 4 years ago when competition heated up. That’s why I purchased back then. Changing a company’s culture takes time but it worked.
Nicholas Ward profile picture
The data speaks for itself: 8 consecutive quarters of negative growth. I too bought in the past during the negative revenue streak, but I also acknowledged that I was speculating on the turnaround.
wxprw714 profile picture
Interesting. You waited for improved results only to find that other buyers had noticed the same thing and driven up the price ahead of you. Imagine that! Please don't take offense; my observation is offered with the kindest of intentions. Your experience supports the old advice to be greedy when others are fearful and fearful when others are greedy. I bought most of my shares down around $18 about five years ago and have been very pleased with the results.
Nicholas Ward profile picture
That is indeed what I did. I was much more willing to take risks several years ago when I picked up CSCO in the low $20's; my large exposure (I don't want to go too overweight) and changing market dynamics have lowered my risk threshold, in general, and for CSCO specifically. Once I've built a strong position in any company it takes considerable weakness for me to add, otherwise it wouldn't be long before I owned too much.
Nicholas -

You did well. I bought higher as the company proved to me they can make money and will be around in the future.

Another subject that is written about often is averaging down. That is what I did several times to get the basis down to about 26.

Yes, I paid up on the original purchase but that was my insurance the company would be around and not go under. It was averaging down on either bad news or a bad market where I was able to add at lower prices to get the current cost down to where it is.

The dividend also keeps me hanging in and not selling as their history from 6 cents in 2011 to the current 33 with a yield of 3% is OK with me.
Nicholas Ward profile picture
Alie, dividend yield/growth is surely a nice reason to stay into a stock. I know it helps me to be patient; I'm much more willing to sell non-dividend paying equities (whether that's into weakness during times of trouble or into strength as valuations rise) than I am the ones that pay me a reliable yield. From a DGI standpoint, CSCO is a wonderful company for sure.
Mike Nadel profile picture
Hi Nick.

I have never owned CSCO. Nothing against it; I just chose other investments (including MSFT and AAPL) when I had $$$ available.

Your conclusion about what you will do with your current CSCO position and when you might add to it mirror what I think about a majority of my holdings. I am comfortable owning them, I "like" them (for lack of better word), and I have no interest in selling them, but I am willing to add only at my price.

The exception I make is that I do drip just about everything I own. That way, I'm always adding a little more whether the market is up or down. Not saying that is the "right" way to handle divvies and all other ways are "wrong," just stating what I do.

Cheers, and thanks for the good article.

Nicholas Ward profile picture
Mike, it seems like we're in agreeance there (minus the DRIP thing). I've often thought about the notion that is a stock isn't a buy, then it should be a sell - I think some people manage their portfolio this way and I don't fault them for doing so, but that adds in a lot more turnover and probably isn't the best path for someone to take who is interested in growing their passive income stream (if I sold all of my holdings that weren't in my buy range right now I would be sitting on like 94% cash and wouldn't have hardly any dividends rolling in).
" Not saying that is the "right" way to handle divvies and all other ways are "wrong," just stating what I do."

Mike -

Imagine the amount of cash you would have to buy other comapnies such as Costco if you didn't reinvest at higher prices.

Additional reasoning - - If a stock is at 45 and you have a target price to buy at 40 and it hits that price you would buy. Now you then turn on reinvest and as the stock hopefully creeps up to the 45 dollar amount you would still be buying shares at that price when originally you did not want to.

I know a book(s) could be written on this subject if it hasn't been done yet.

Mike Nadel profile picture

The thing is ... I don't know if I am investing at "higher prices."

To many, BA was at "higher prices" when it hit 175. MO was at "higher prices" when it hit 40. V was at "higher prices" when it hit 60. MMM was at "higher prices" when it hit 160. MSFT was at "higher prices" when it hit 55. And so on and so on and so on.

The vast majority of my holdings are companies I "really like" (for lack of better phrasing). I always want more of them!

I don't think you'll see 39 again unless there is a major market correction or the company comes out with terrible news and then you may not buy at all.
matttrakker profile picture
I agree. The company has turned the corner and is growing. Next is multiple expansion. If you don’t get in soon you will just miss it.
Nicholas Ward profile picture
Maybe. With that said, my cost basis is something like $24 and I haven’t been holding for all that long. The market has a habit of giving good prices to those who wait. As I said in the piece, my current position is large and if it runs, it runs. I won’t be upset.
grebb profile picture
Nicholas, I enjoyed your article and am glad you’ve had investment success with CSCO, but don’t understand your interest in cost basis and yield on cost. Both of those measures represent sunk cost decisions, and shouldn’t affect how one would view the future expectations about the share price. I don’t consider my cost basis when forming my investment thesis for a stock, since I’m more interested in where I project the share price will be going forward, rather than where it’s been since the day I made my initial purchase. What are your thoughts?

Good article. I believe Cisco stock will do well over the next few years. I am glad to see you touched on the fact that Cisco's turn around is based on accounting and an increase in revenues from the switch to software licenses. Until this quarter Cisco had 9 down revenue quarters to set this up. I believe Cisco will now have 8 or more up quarters as the software licensing works it's way through the system. Everyone should be aware of one thing and that is Cisco continues to lose market share in a market that is estimated to be growing at 2%.
Nicholas Ward profile picture
Terry, thanks for stopping by. I agree that growth from here on out is likely, but it will be slow. I see this as an income oriented holding more than anything else. That isn’t necessarily a bad thing, but it also means I’m not willing to pay a premium for shares.
Nice article on Cisco , would you consider selling out of the money puts to increase your position
And create more income ?
Nicholas Ward profile picture
I don’t really mess around with options; I don’t like the idea of being forced to buy or sell at anytime ($39 seems attractive ATM, but that could change).
dbchambers profile picture
Tech dividends are good - but I would rate MSFT and AAPL ahead of CSCO.
CapeCapMgmt profile picture
I agree db, but I have all three because I do indeed like CSCO as well.
dbchambers profile picture
CCM - I agree - I had Cisco in my Direct portfolio. Sold and added to my MSFT total.

Most of most portfolio is managed by a CFP (neighbor from college).

Sticking to diversification, I have two techs , with Apple a tweener of consumer and tech. Thanks for the reminder. Continue to watch CSCO for a lower price entry.
Nicholas Ward profile picture
DB, I agree as well. AAPL is my largest holding and MSFT has a higher weighting than CSCO in my portfolio as well. That said, I like to be diversified and I think CSCO’s dividend is solid.
I bought CSCO 20 years ago and for most of the time it looked like a big dot-com mistake (definitely made much worse ones) and Chambers used to say buy-backs were the reward for the investor ....... Long after other tech companies started to pay dividends, he finally acquiesced and I'm so glad this purchase, now at ~2.5 x original purchase price, is an asset and the dividend in my retirement is very welcome.
Nicholas Ward profile picture
Liberty, congrats on your success here!
gametv profile picture
cisco has a long way to go to actually improve their business fundamentals. the market is heavily over-valuing the recent changes to the business. sure they are transitioning to services revenues, but the topline is only growing by 3-5% in a very good market.
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