Over the course of its 29 year history, the San Jose-based broadband networking giant, Cisco Systems (CSCO - Free Cisco Stock Report), has lived up to its reputation as an industry pioneer, becoming the world’s largest manufacturer of computer networking equipment, and one of the most successful companies to emerge from the golden era of Silicon Valley. Indeed, the company has established and fortified a brand of quality and innovation that has helped it to reign as ‘king of the mountain’ in the network engineering space for decades. Taking a look at the Commentary section of the Value Line report on Cisco, analyst Kevin Downing notes that “Cisco’s ability to sell related products to large customers and the long, quality relationships this helps maintain” has provided a considerable competitive edge over its industry peers. Mr. Downing goes on to state that “this ‘architectural’ sales approach provides more value, keeps customers coming back, and helps Cisco win head-to-head battles against rivals that only offer one or two products.” With this in mind, our aim is to evaluate the various metrics that make this market-leading technology outfit a solid choice for the value-oriented investor seeking a standout, blue-chip dividend growth play.
First, we will identify the ratios and fundamentals that support Cisco’s growth appeal. Hence, a glance at the Price-to-Earnings Ratio at the top of the page, which is listed as 11.5x projected 12-month earnings per share (currently approximately 12x based on the closing price on 7/11/13; using the Value Line methodology), seems well below the company’s historical average. Normally, this would be a major sign that the stock is undervalued. However, some may argue that the lower P/E reflects the company’s slower earnings growth expectations over the coming years. Shifting over to the Annual Rates box, it is evident that Cisco’s growth rates for sales, cash flow, and earnings have slowed over the past 10 years. Moreover, our projected growth rates over the next 3 to 5 years are even lower still.
Nonetheless, the stock’s price momentum over the past 52-weeks has been impressive, up about 73%. Granted, this is coming off of a low base, as a corporate IT spending drought and challenging economic conditions over the past few years weighed on the equity in 2011 and kept it fairly range-bound for most of 2012. Still, we believe investors have finally come around and have been responding favorably to Cisco’s strong earnings performance over the past 3-plus years, despite the tough market conditions. Indeed, a quick glance at the Statistical Array and Earnings per Share box demonstrates the company’s year-to-year earnings advances. Moreover, after years of corporate cost cutting and shoring up liquidity, the global economic recovery has begun to gradually gain traction. Hence, the potential for the unlocking of pent-up demand and the likelihood that corporations will open up there cash-flush coffers to invest in technology infrastructure, rather than costly physical expansion, will probably prove to be a considerable windfall for Cisco. Notably, the company’s proactive efforts to shift its business model towards higher-margined growth-driven products and services should further support sales and earnings gains going forward.
Still, while these factors are promising, there is some concern that the aforementioned earnings growth potential has already been discounted, as CSCO shares are now trading at a new 52-week high and nipping at their multiyear peak of $27.70. That said, we believe the proverbial cherry on top here is the attractive Dividend Yield(found in the Top Label), which at 2.8%, is quite generous for a tech stock. Indeed, the company has considerably ramped up its dividend payouts since the initiation in 2011. Moreover, the Financial Estimates in the Statistical Array area of the Value Line page indicates that we expect Cisco to continue to increase its distributions over the next 3 to 5 years, albeit at a lesser rate than in recent years.
All told, we believe that Cisco may prove to be a long-term equity turnaround story that has yet to fully unfold. Indeed, our sales and earnings growth projections could well be somewhat conservative, should the global economic recovery accelerate faster than we anticipate. For now, however, the stock should continue to win favor among momentum-driven investors seeking a high-quality issue (see the Ranks box; Timeliness: 1, Highest; Safety: 1, Highest) that offers a solid amount of income to boot.
At the time that this article was written, the author held no positions in any of the companies mentioned.