Have you ever walked down the street and found a dollar bill lying there, with nobody to claim it but yourself? How about a twenty dollar bill? It is certainly not the most glamorous way to make a buck, but it definitely works.
How does this relate to investing? Value investors are those who search the globe for those dollar bills lying on the street that others have left or just plain neglected. Today Cisco (CSCO, Financial) is one of those dollar bills lying on the street. Actually it’s ninety five billion dollars lying on the street.
Why is Cisco neglected? Good question. Let’s back up. As the designer of the hardware and plumbing of the network (internet, wireless, etc.), Cisco was once touted as the growth company to end all growth companies. In March 2000 the company had a market capitalization (the stock price multiplied by all outstanding shares) of $450 billion dollars. Many “experts” speculated that Cisco would be the first trillion dollar company. To me this is odd, and frankly inconceivable, considering that in 2000 the company earned total income of $2,668 million dollars. The cash flow of the company that year was $6,141 million. Due to arcane accounting for stock options they received $2,495 of that cash flow as a tax benefits from employee stock options plans. That accounts for 40.6% of their cash flow, which is not very economically helpful. This implied a market price to earnings ratio of 168 times. How ridiculous. (Don’t get me started about today’s growth company, Netflix, whose market capitalization implies world domination)
Today that scenario has changed. Cisco is no longer the growth company of the century. Analysts are expecting the company to have margin pressures due to cheap competitors, mainly from China. In fact the company is experiencing difficulties as their consumer business is hurting and new products are being released at lower price points. The investment community is punishing the stock by driving the price down to very low levels. As of this writing the stock is down ~15% for the year.
I would pick this dollar up off of the street and put it in my pocket. There are a lot of factors that make this a good investment opportunity. First, is the forty billion dollars they have in cash and investments on their balance sheet. Take that out from the current market price of ninety five billion dollars and you are left with an implied enterprise value of the company of fifty five billion dollars. Roughly compare that to their fiscal year 2010 earnings of $7,767 million and you have a price to earnings ratio of seven. Now we are talking. Free cash flow (cash from operations less capital expenditures and any stock dilution) of the business was roughly the same as earnings. Theoretically the company can buy itself up by buying back shares and it would only take seven years. How about that for value?
What about the margin pressure and growth opportunities? John Chambers is an excellent CEO. He has made his mistakes in the past and will probably make them in the future, but he will drive growth in the business and will improve the margins. If you doubt those words, take a look at his operational performance after the tech bubble. Even over the last five years he has grown revenue 60% and earnings 35%!
Valuation
Return on capital is very important in business. Why waste capital on low return business. Take out the extra cash the company has hoarded over the years and the average ROC of the main business has been around 30%. A return of capital of 30% is the sign of a wonderful company that dominates their market. (Which Cisco does, even with the last couple years of competitor pressure) This is a huge competitive advantage for a variety of reasons. At a 6% earnings yield that would amount to 5 times capital. Using the most recent 2nd quarter numbers an enterprise value of one hundred and eight billion would be implied. Compare that to the fifty five billion dollars the market is assuming and you have yourself a deal. Buying the company now and you would have almost a 14% earnings yield.
Patience
Nothing works out as quickly as the general population wants. This idea will take time and patience is required. The company is moving in the right direction as far as paying out dividends to shareholders. With forty billion to spare, an investor in Cisco will be paid to wait as the company increases it value and the market starts noticing. Patient investors will profit handsomely from an investment in Cisco.
How does this relate to investing? Value investors are those who search the globe for those dollar bills lying on the street that others have left or just plain neglected. Today Cisco (CSCO, Financial) is one of those dollar bills lying on the street. Actually it’s ninety five billion dollars lying on the street.
Why is Cisco neglected? Good question. Let’s back up. As the designer of the hardware and plumbing of the network (internet, wireless, etc.), Cisco was once touted as the growth company to end all growth companies. In March 2000 the company had a market capitalization (the stock price multiplied by all outstanding shares) of $450 billion dollars. Many “experts” speculated that Cisco would be the first trillion dollar company. To me this is odd, and frankly inconceivable, considering that in 2000 the company earned total income of $2,668 million dollars. The cash flow of the company that year was $6,141 million. Due to arcane accounting for stock options they received $2,495 of that cash flow as a tax benefits from employee stock options plans. That accounts for 40.6% of their cash flow, which is not very economically helpful. This implied a market price to earnings ratio of 168 times. How ridiculous. (Don’t get me started about today’s growth company, Netflix, whose market capitalization implies world domination)
Today that scenario has changed. Cisco is no longer the growth company of the century. Analysts are expecting the company to have margin pressures due to cheap competitors, mainly from China. In fact the company is experiencing difficulties as their consumer business is hurting and new products are being released at lower price points. The investment community is punishing the stock by driving the price down to very low levels. As of this writing the stock is down ~15% for the year.
I would pick this dollar up off of the street and put it in my pocket. There are a lot of factors that make this a good investment opportunity. First, is the forty billion dollars they have in cash and investments on their balance sheet. Take that out from the current market price of ninety five billion dollars and you are left with an implied enterprise value of the company of fifty five billion dollars. Roughly compare that to their fiscal year 2010 earnings of $7,767 million and you have a price to earnings ratio of seven. Now we are talking. Free cash flow (cash from operations less capital expenditures and any stock dilution) of the business was roughly the same as earnings. Theoretically the company can buy itself up by buying back shares and it would only take seven years. How about that for value?
What about the margin pressure and growth opportunities? John Chambers is an excellent CEO. He has made his mistakes in the past and will probably make them in the future, but he will drive growth in the business and will improve the margins. If you doubt those words, take a look at his operational performance after the tech bubble. Even over the last five years he has grown revenue 60% and earnings 35%!
Valuation
Return on capital is very important in business. Why waste capital on low return business. Take out the extra cash the company has hoarded over the years and the average ROC of the main business has been around 30%. A return of capital of 30% is the sign of a wonderful company that dominates their market. (Which Cisco does, even with the last couple years of competitor pressure) This is a huge competitive advantage for a variety of reasons. At a 6% earnings yield that would amount to 5 times capital. Using the most recent 2nd quarter numbers an enterprise value of one hundred and eight billion would be implied. Compare that to the fifty five billion dollars the market is assuming and you have yourself a deal. Buying the company now and you would have almost a 14% earnings yield.
Patience
Nothing works out as quickly as the general population wants. This idea will take time and patience is required. The company is moving in the right direction as far as paying out dividends to shareholders. With forty billion to spare, an investor in Cisco will be paid to wait as the company increases it value and the market starts noticing. Patient investors will profit handsomely from an investment in Cisco.
