Coming into the year, Cisco Systems’ (CSCO – Free Value Line Research Report on Cisco) CEO John Chambers was standing behind the company’s long-term revenue projections of 12% to 17% annual growth. Then, in what was a market shocker, he sent a memo to his employees acknowledging that unacceptable operational execution had disappointed investors, confused employees, and caused the company to lose credibility with its customers.
In keeping with his aggressive, no-nonsense management style, Mr. Chambers has expressed his intent to take sweeping action to streamline operations. After the 2007 decision to alter the company’s organizational structure and entering 30 new markets over a three-year time frame, the uncharacteristic misstep was, perhaps, inevitable. Chambers lowered, “temporarily,” the company’s revenue growth rates to the 9% to 12% range for 2011.
The hangover from the overly aggressive push, however, isn’t over. The company just recently lowered its revenue target even further to 5% to 7%. The “cockroach theory” seems fairly applicable here—if there is one problem, there’s likely to be more that you can’t see yet. As the Graph clearly displays, investors have taken a dim view of this almost constant negative news, taking the shares from a high of about $27 in 2010 to recent lows near $13. (The high and low prices for every year can be found above the Graph.) Is the damage overdone?
Value Line’s proprietary Timeliness Ranking System seems to suggest it is not, giving the shares a 4 (Below Average) rank. The Value Line Timeliness rank, found in the Ranks box at the top left of the report, measures the probable relative price performance of approximately 1,700 stocks during the next six to 12 months on an easy-to-understand scale from 1 (Highest) to 5 (Lowest). The components of the Timeliness Ranking System include the 10-year trend of relative earnings and prices, recent earnings and price changes, cash flow and earnings surprises. All data are actual and known. A computer program combines these elements into a forecast of the price change of each stock, relative to all of the approximately 1,700 stocks for the six to 12 months ahead.
A rank of 4 isn’t good. That said, the Ranking System is geared toward growth and momentum, not value. So, for those seeking a growth investment, the best advice right now is likely to avoid Cisco stock. For investors in search of value, however, the rank shouldn’t necessarily drive one away. Cisco and many other now-large technology companies are going through a massive shift. They are transitioning from high-growth oriented companies into slow and steady growers. These types of transitions aren’t pretty, as management is usually as unhappy about the transition as investors. As that dissatisfaction is expressed in a lower share price, intrepid value-oriented investors may find opportunity.
At the recent price, the shares are trading at valuation levels at the low end of its historical range over the past 17 years. Indeed, the P/E ratio relative to that of the average stock covered by Value line, shown at the Top Label section of the page, is 1.00—on par with the market. A review of the historical portion of the Statistical Array quickly shows that the shares normally trade at a premium to the market. So, the shares are relatively cheap compared to their history.
If the company is transitioning to a slower growth rate, though, a new P/E multiple range is probably appropriate. Although this is true, Cisco is still a dominant and inventive company that would seem to have more going for it than the average company. For example, it spent over $5 billion on research and development in 2010. (This figure can be derived by taking the 13.2% of revenues spent on R&D figure from the Business Description and multiplying it by the revenues for 2010 found in the Statistical Array.) Moreover, Cisco has material market positions in key industry segments including networking and video.
Additionally, while the recent missteps are upsetting, Cisco has some $44.5 billion of cash on its balance sheet (which can be seen in the Current Position box). That figure, meanwhile, is up from 2009—the period in which the company suffered operational issues. Additionally, its cash balance is well over twice the company’s debt. Clearly, the company is financially strong (note the A++ Financial Strength Rating in the Ratings box at the bottom right of the report) and can afford the time it may take to get back on the right track.
The company also initiated a dividend this year. (As the Quarterly Dividend box shows, the first payment occurred earlier this year.) Although the dividend yield isn’t what one could call large, it shows that management is cognizant of the need to give back to shareholders in new ways.
It is clearly possible that there are more cockroaches hiding at Cisco. That said, the company appears to understand the problems it faces. While it may take some time for Mr. Chambers and company to right the ship, they have the financial wherewithal to get through it. Value investors should take a close look here.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.