COMMENTARY | COLUMNISTS | BRENT WILSEY

Cisco is a company worth watching for investors

Many people think the way to make a lot of money in the stock market is to find the next Apple and have it grow 2,000 percent over the next few years.

While this method will work on paper, it is nearly impossible to find the next Qualcomm or Apple that is going to skyrocket to the moon.

Investors also fear the coming increase in interest rates and how it could derail stocks. It has been proven many times that investing in undervalued companies can produce a decent longer term return for investors if done properly.

Investment firm Credit Suisse recently released a study of which type of stocks do best when yields on two-year Treasurys increase. What the study found was that companies that were rebuilding or fixing some problem with their business and the valuations were undervalued performed better than what is known as “best of breed” or the momentum stocks with lofty valuations. The reason cited for this was that along with rising rates generally comes an improving economy that can help a restructuring company more than a richly valued company.

One company that could fit into that category would be technology giant Cisco. I received a request to look into Cisco by a radio show listener. Coincidentally, Ken and I have been looking at this company as a potential long-term buy.

What I liked even more is that this listener and others have become disenchanted with Cisco because the stock has not been a big mover. I will say if one overpaid for this or any company for that matter, your investment results will not be satisfactory.

Cisco, which trades under the symbol CSCO, over the last five years has traded as low as 15 back in mid-2009 and again in the summer of 2011. The high was near 27 in the summer of 2010 and it rose slightly above 26 last summer.

What I find most interesting in this company is that over this time period, the earnings per share have climbed 77 percent from full year earnings per share of $1.05 for the year ending July 25, 2009, to $1.86 for the year ending July 27, 2013.

Let me state again that is a 77 percent increase in EPS versus roughly a 10 percent increase in the stock price over the same period. The equity for the company in July 2009 was $38.6 billion, today it stands at $59.1 billion, a 53 percent increase.

Some other important numbers would be the valuation ratios, starting with the current PE for Cisco. It stands at 11.5, well below the industry average of 16.6 and the forward PE stands at only 10.1. Price to sales is 2.3 for the company, which is also below the industry average of 2.7.

Price to book value also favors the company at 3.6, which is better than the industry average at 4.3. Lastly, the price to cash flow also favors the company at 9.2, compared to 11.5 for the industry, sweeping all the valuation ratios in favor of Cisco.

Investors can also get excited about the current dividend yield to 3.2 percent, much higher than the industry average of 2.4 percent, and Cisco uses only 34 percent of their earnings to pay that divided. Also keep in mind that the company is sitting on $48 billion in cash and last year had cash flow of over $12 billion, or $1 billion per month. Do you think we could see an increasing dividend in the coming years? I do.

If you want to find something wrong with the company’s financial fundamentals, one could complain about sales growth of only 4.6 percent year over year when the industry did grow their sales 8.1 percent for the same period. One could also complain about earnings per share growth of only 18.3 percent year over year when the industry grew its EPS by 26.4 percent, but how can one really complain about an 18 percent growth in EPS?

The balance sheet for Cisco is strong with a debt to equity of 27.5, slightly higher than the industry average of 22.9. The current ratio is exactly the same for both the industry and the company at 2.89, demonstrating both good liquidity and bill-paying capabilities.

Cisco has a return on equity of 17.7 percent, which is above my benchmark of 15 percent and also above the industry average of 15.4 percent. The net profit margin for Cisco is 25 percent higher than the industry average, coming in at 20.3 percent when the industry could squeeze out only a 16.2 percent profit margin.

When it comes to efficiency, well-respected CEO John Chambers has done a great job of managing this business. The receivable turnover is 10.7 over the past 12 months for Cisco, compared to the industry average of 6.7 times. Inventory turnover for Cisco is nearly double the industry average over the last 12 months at 12.1, versus the industry average of 6.44.

Looking forward there are 32 analysts who have a mean estimate of $2.10 for earnings per share coming July 2015; the low estimate is $1.92 and the high estimate is $2.30. Using a conservative multiple of 16.5, that would yield a target sell price of $34.65, a potential 65 percent gain, not including dividends. The company’s PEG ratio is only 1.28, giving investors the understanding that they are not paying too much for the future earnings of Cisco.

Cisco reminds me a little of Microsoft, where it did nothing for years bouncing around the mid-20s. Today Microsoft is in the high 30s, delivering a good investment return for the patient investor.

I can’t tell you when or guarantee that Cisco will take the same course as Microsoft. What I can tell you is that this is a well-run business in a growing industry managed very well by the current CEO. To me that has all the ingredients of a growing company, which should be reflected in the stock price in the future.

Have a question or a company you'd like me to take a look at? Email me at brent@wilseyassetmanagement.com.

Wilsey is president of Wilsey Asset Management and can be heard at 8 a.m. every Saturday on KFMB AM760. Information is provided by Reuters.

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