Is Cisco As Cheap As It Looks?

Cisco Systems, Inc. (NASDAQ:CSCO)’s fiscal year ended in July, with the company reporting strong numbers for the fourth fiscal quarter that brought its revenue 7% higher for the year than in the last fiscal year and earnings up by 24%. Many of the company’s costs were held flat or even declined, most notably sales and marketing expenses. Cisco’s ongoing heavy buyback program (the 10-K reported that $4.8 billion in cash was used to repurchase common stock), helped pull earnings per share up even further, at a 27% rate. While we wouldn’t suggest that the large networking and communication devices company will see this growth rate in the current fiscal year, it probably shouldn’t see a sharp decline either and modest growth is probably the base case scenario.

Ken Fisher FISHER ASSET MANAGEMENT

Yet Cisco Systems, Inc. trades at fairly low earnings multiples: 12 times trailing earnings and 9 times estimates for the current fiscal year (and keep in mind that extended buybacks will likely augment higher net income). This is because despite the better bottom line the stock is actually down 4% from a year earlier, while the broader market indices have seen returns of 10% or higher. Cisco also pays a good dividend (it increased its payment recently) and therefore has a yield of 3.2% to return additional cash to shareholders. The stock therefore looks cheap as long as it can deliver small growth rates in its business going forward.

Billionaire Ken Fisher’s Fisher Asset Management made a large purchase of Cisco shares in the second quarter of the year, and owned 21 million shares at the end of June (see more of billionaire Ken Fisher’s stock picks). First Eagle Investment Management also liked the stock: that fund also bought shares during the second quarter, and its 13F filing listed Cisco Systems, Inc. as the largest position by market value in First Eagle’s portfolio with a total of 46 million shares (research other stocks that First Eagle liked). Sandy Nairn’s Edinburgh Partners cut its stake by 12% but still reported owning 14 million shares of the company;p this made it one of the top picks in Edinburgh’s portfolio as well (find other top picks from Edinburgh Partners).

To construct a peer group for Cisco, we’d look at Alcatel Lucent SA (NYSE:ALU), Juniper Networks, Inc. (NYSE:JNPR), Palo Alto Networks Inc (NYSE:PANW), and Riverbed Technology, Inc. (NASDAQ:RVBD). On a forward basis, Cisco is by far the cheapest of these comparable companies. The two which are priced the closest are Riverbed and Juniper, which both carry forward P/Es of 16. Juniper had a bad third quarter: its revenue was up slightly compared to the third quarter of 2011, but its earnings plummeted. With its forward P/E actually depending quite a bit on expected growth, we’d avoid it. Riverbed is more appealing, as it grew both its top and bottom lines at double-digit rates last quarter versus a year earlier. Its valuation anticipated quite a bit of continued growth, so we’d still consider Cisco to be the better value.

Alcatel-Lucent has had its stock price cut in half over the last year, and still trades at 20 times consensus estimates for its 2013 earnings. This is because its revenue has been down, and it is struggling with profitability (earnings were negative in each of the first two quarters of 2012). We don’t think it’s reached the point yet where it would be a good value. Palo Alto seems to be the fastest-growing of these companies; in its most recent quarter sales were nearly double what they were a year earlier. It is probably good to keep an eye on such a rapidly growing company, but the stock price is a bit high for us for now as it is only seeing 3-4 cents per share in earnings per quarter.

We think that investors should take a look at Cisco. Its pricing is fairly cheap (including relative to its peers), the company has a commitment to returning cash to shareholders, and growth looks to be at least modest in the near future.

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