Cisco Systems Inc (CSCO): Buy! or Bye Bye?

The analysts’ consensus estimate of EPS growth through fiscal 2014 for Cisco is 18%, which yields a forward PE of under 10x and a forward price to earnings to growth (PEG) multiple of 0.5x.  This compares very favorably to the 1.6x PEG multiple of Juniper, which analysts estimate will grow earnings by around 13% over the next two fiscal years.  Hewlett-Packard, which reported an earnings loss for the October 2012 fiscal year, is expected to grow its EPS by 8% in 2014 which indicates a forward PEG of 0.6x.  Cisco is my preferred stock based on this preliminary look at PEG, but a deeper dive into the catalysts for the estimated growth rate of each company is needed to determine their reasonableness.  This effort might suggest, for example, that Hewlett-Packard is a better prospect at its current price if you believe that CEO Meg Whitman will succeed in turning around the company.

At its recent price and an estimated EPS growth rate of 8%, Sysco trades at a PEG multiple of 1.7x, which is near the high end of my preferred 1x-2x range.  For comparison, Kroger carries a PEG multiple of 1.3x with analysts estimating forward EPS growth of about 7%.  A company trading closer to 2x than 1x often has a high growth rate (usually above 15%) and a high PE as investors chase that growth.  In the case of Sysco, the growth rate is not high, but is elevated above its own historic level of around 5%.  The current PEG multiple appears reasonable given that EPS growth is expected to be higher than in the past and the forward PE of under 14x is below the long term trailing PE average of around 16x.  I am reasonably confident that this growth rate can be achieved, and thus the PEG justified, given the room Sysco has to improve its profit margins if revenue growth is stable.

Examining the metrics of companies in unrelated industries can illustrate facts that confirm our assumptions about the respective companies or that are counter to these assumptions.  In the case of Cisco vs. Sysco, the most striking metric to emerge was their underperformance relative to the S&P 500 over the past decade despite returns on invested capital at about 16% and 20%, respectively.  At these levels, the companies are clearly creating value by earning more than their cost of capital.  Because the market has not rewarded this value creation, Cisco and Sysco are interesting long term holdings that ultimately should outperform the broad market.

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