Cisco: A String-of-Pearls Strategy

12/29/2015 8:00 am EST

Focus: STOCKS

Richard Moroney

Editor, Dow Theory Forecasts

Our latest featured recommendation—a leading provider of computer-networking gear—recently cautioned about soft spending for US companies and sluggish overseas markets, explains Richard Moroney, editor of Dow Theory Forecasts.

Cisco Systems (CSCO) fell after the company gave disappointing guidance for the January quarter. The strong US dollar continues to weigh on international sales, about 47% of Cisco’s total revenue. 

Its largest business—switches—faces pricing pressure, partly due to cheaper alternatives. And the strong US dollar continues to weigh on international sales, about 47% of Cisco’s total revenue. 

Nevertheless, Cisco offers steady, if unspectacular, growth. For the 12 months ended October, per share profits from operations rose 13%, while sales, operating cash flow, and free cash flow all increased 5%.

Over the past 24 quarters, a stretch dating back to November 2009, sales have risen in 21 quarters, earnings per share from operations in 19 quarters, and operating cash flow in 17 quarters.

The company has eschewed the big deals many rivals rely on to drive growth. From fiscal 2011 ended July through fiscal 2015, Cisco completed 40 acquisitions for a total of $11.18 billion; just two of the deals were valued at more than $1 billion.

Cisco intends to continue this string-of-pearls strategy, announcing four more deals worth a combined $1.93 billion since July 30.

Routers and switches remain a crucial but diminishing part of Cisco’s business, combining for 46% of total sales in fiscal 2015, down from 63% a decade ago.

In recent years, Cisco has expanded its services business, while pushing into such new avenues as digital video systems, data-center equipment, wireless, and security solutions.

Cisco returned 73% of free cash flow to shareholders through stock buybacks and dividends in fiscal 2015, followed by 91% in the October quarter (comfortably above its minimum target of 50% of annual free cash flow).

Stock buybacks shaved 10% from the share count over the past five years. The quarterly dividend pays $0.21 per share, up from $0.06 per share when Cisco initiated the distribution in 2011. Cisco’s 3.1% yield ranks in the top 20% of dividend-paying stocks in the S&P 1500 technology sector.

Shares trade at 12 times trailing earnings, a 13% discount to their five-year average and 27% below the median for S&P 1500 communications-equipment stocks. The trailing P/E is just nine excluding net cash of $34.49 billion, nearly $7 per share.

Overall, Cisco’s management tends to be conservative and the company enjoys an excellent track record for exceeding expectations. Cisco is a Long-Term Buy.

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