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Buy Cisco Systems, Inc. (CSCO)

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Cisco Systems, Inc. (NASDAQ:CSCO) designs, manufactures, and distributes networking equipment. The company’s primary customers are enterprises around the world although Cisco also makes consumer networking equipment such as routers through its Linksys line. Cisco also makes digital TV boxes. In 2012 the company derived about 55% of its revenue from enterprise networking switches and services. Routers and network security and miscellaneous products made up another 30%. The consumer business accounted for around 9% of Cisco’s revenue.

The company has a commanding 68% market share in network switches as of Q3 2012, along with 62% market share in routers, 55% in wireless local area networks (LAN), 50% in telepresence, and more than 40% share in storage, voice, and web conferencing.

Cisco Systems Vs. Competitors

Cisco Systems, Inc. (NASDAQ:CSCO) is classified as a Communications Equipment sub-classification of the Technology Sector. The company has several competitors but we have selected for comparison two that compete primarily in the mobile space, a key for Cisco’s future growth. The competitors are QUALCOMM, Inc. (NASDAQ:QCOM) and Ericsson (ADR) (NASDAQ:ERIC).

Cisco Systems, Inc. (NASDAQ:CSCO)The world’s largest mobile telephone network equipment provider, Ericsson recorded a net loss for Q4 2012 due to writing down the value of  the unprofitable smartphone component (ST-Ericsson). In sales, the figures skyrocketed. In the U.S. and Canada alone, sales of mobile broadband and network gear improved by a whopping 86%. By writing down a non-performing company of 5,090 workers, Ericsson will not only improve its ROE but also cut down costs for the future.

With the acquisition of Atheros Communications, Qualcomm has strengthened its leading position in providing wireless communication equipment. With its Snapdragon processors in demand for Google devices and now a potential low-end iPhone from Apple, Qualcomm is expecting an incremental increase in revenue for every phone sold. While priced on the expensive side, Qualcomm has no debt for investors to worry about.

There are many ways how to estimate the fair stock price of a company. One of these ways is the discounted-earnings-plus-equity model developed by EFS Investment analysts. The following table compares some key stock metrics across the three competitors:

Indicator
Cisco

Qualcomm

LM Ericcson Telephone
Price/Earnings ttm 12.1 19.6 42.6
Price/Book 2.0 3.2 1.8
EPS Growth (3 Year Avg.) 12.4% 54.6% 16%
Dividend Yield, % 2.52% 1.53% 2.55%
Debt/Equity 0.3 0.0 0.2
Return on Equity 17.8% 20.7% 4.1%
Current Price 20.64 64.24 11.83
Estimated Fair Value Range $27-$38 $73-$93 $8-$15
Stock Valuation Undervalued Undervalued Fairly Valued
Upside Potential to Reach Fair Value 33% 13%

Data from Morningstar and Financial Visualizations on April 18, 2013

According to the model, currently two stocks (Cisco and Qualcomm) are undervalued. EFS’s fair stock price valuation suggests that Cisco Systems, Inc. (NASDAQ:CSCO) is trading at the most attractive discount.

In addition, Cisco seems to have the best combination of metrics when you compare its low P/E and respectable P/B, EPS Growth, and ROE. The dividend yield is stellar, although Cisco does have the highest debt to equity ratio, but not by much and the ratio is well within safe limits. Cisco’s dividend is solid, having increased dividends per share every year for the last decade from a low of $0.09 in 2003 to $1.15 in FY 2012.

What does the Future Hold?

The Cisco Corporate Overview from the company website makes the astounding claim that 99% of the world is still “unconnected.” Add to that the explosive growth in mobile devices and Cisco is well-positioned for future growth. Wireless carriers need to expand current networks to keep up with demand. A 2013 Cisco study claims the demand for mobile video usage will grow to comprise close to two thirds of all mobile use by 2017.

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