Cisco Systems, Inc. (CSCO, Financial) enjoys one of the highest profitability ratings among American stocks with a GuruFocus score of 9 out of 10. It is also available at a discount, according to the new GuruFocus valuation infographic:
The infographic has several components. First, GF Value, the black line running horizontally across, represents the current estimated intrinsic (or fair) value of a company's stock. The GF Value is based on three factors:
- Historical multiples of price-earnings ratio, price-sales ratio, price-book ratio and price-to-free-cash-flow ratio.
- A GuruFocus adjustment factor based on previous returns and growth.
- Future estimates of how the business will perform.
Stocks trading above the black line are considered overvalued and have no margin of safety. Prices below the black line are undervalued and do have a margin of safety. Thus, value investors will most likely want to buy when the price is below the line (and perhaps sell when the price is above the line).
The blue line is the share price, while the red, white and green bands are ranges of prices. The redder a band, the more overpriced the stock, while the greener a band, the more underpriced it is.
As we see in the chart, Cisco is considered modestly undervalued, and therefore worth consideration by value investors.
The company describes itself this way in its 10-K for 2019: "Cisco designs and sells a broad range of technologies that have been powering the Internet since 1984." Its products and services are divided into three categories: Infrastructure Platforms; Applications; and Security and Other Products.
In the 10-K, it also specifically mentions intent-based technologies, a newer concept that aims to meet the challenges of integrating IT and businesses. On its website, the company wrote:
"Intent-based networking captures business intent and uses analytics, machine learning, and automation to align the network continuously to changing business needs, which can include application service levels, security policies, regulatory compliance, and operational processes."
Cisco is a member of the S&P 100, with a market capitalization of $168.83 billion. In its latest fiscal year that ended on July 25, 2020, it generated revenue of $49,301 billion.
As this 10-year price chart shows, investors have been losing confidence in the company:
Cisco pointed out in the recent 10-K:
"We continue to operate in a challenging macroeconomic and highly competitive environment. We saw broad-based weakening in the global macroeconomic environment during the fiscal year which impacted our commercial and enterprise markets. We also experienced continuing weakness in the service provider market and emerging countries, and we expect ongoing uncertainty in these markets."
Additionally, it pointed out that it had managed to increase its margins and its earnings per share. For long-term investors, those two metrics will matter much more than the immediate share price.
Financial strength
Cisco does have debt, but the data on the above table shows it has relatively average leverage. The cash-debt ratio of 2.02 means the company has enough cash, cash equivalents and marketable securities to pay off its debts twice over.
Similarly, the interest coverage ratio of 24.1 means it has enough operating income to pay its interest expenses 24 times over.
Those positive numbers are backed up by a full Piotroski F-Score of 9 out of 9. Finally, we see its weighted average cost of capital (WACC) of 4.9% is much lower than its return on invested capital (ROIC) of 15.42%, indicating profitability.
Profitability
Only a relatively small number of companies manage to get a profitability rating of 9 or 10, and Cisco is among them. All the green and dark green on the table indicates the company is not only more profitable that the majority of companies in the Hardware industry, but also doing better than it has in the past.
The below chart shows the operating margin and net margin over the past decade:
Revenue has been increasing, and it is reassuring to see the profitability measures of Ebitda and earnings per share increasing even faster. The yellow and red bars in this section of the table alert us that although these three measures are improving, they're not necessarily the best when compared with the company's competitors and its own history.
Valuation
The price-earnings ratio of 15.28 is okay when compared with the competition and good when compared with Cisco's own history. Diving deeper, we find that its price-earnings ratio is ranked higher than 67% of companies in the hardware industry. In the history bar we find that the company's 10-year median price-earnings ratio of 16 is only slightly higher than the current ratio of 15.28.
When we review the PEG ratio (2.11) and the discounted cash flow (DCF) calculator (which shows a 43.45% overvaluation), we get mixed messages. The GF Value indicator gave us a "Modestly Undervalued" signal, while both the PEG ratio and DCF calculator both show the company as overvalued. The difference can be attributed to the criteria by which each valuation is calculated.
Which is more accurate? In my opinion, the GF Value indicator more reasonably reflects the stock's price movement, as it considers a wider range of factors. Here's the GF Value image again:
The share price is well below its recent highs, but also above the most recent lows. Based on the share price alone, we can see it is in the middle and that it is dropping again.
Dividend and share buybacks
The dividend yield is strong, roughly double the S&P 500 average. While affected somewhat by the share price, we see the yield (in red) has been relatively consistent since 2014:
The dividend payout is 55%, which is normal for a mature company and still leaves 45% of free cash flow for growth.
Over the past three years, the dividend growth rate has averaged almost 9% per year. That's well ahead of the rate of inflation and gives income investors a reason to stick with the stock.
The forward dividend yield is up slightly, reflecting an increase in January from $0.35 to $0.36 per quarter.
That increase combined with the existing yield and dividend growth rate add up to a five-year yield-on-cost of 6.35%. That's quite attractive if you hold the stock for five years and the company continues to grow the dividend as it has over the past five years.
Cisco also is returning value to shareholders by buying back its shares. The three-year average share buyback ratio is 5.3, which is relatively high. Combine that with the five-year yield on cost for a handsome return (assuming all the pieces come together).
Gurus
With 25 gurus holding positions in Cisco, it is one the most popular stocks among the elite. That being said, there has more selling than buying of the stock in recent years:
At the end of the second quarter, the biggest guru shareholder was Dodge & Cox which held 27,541,072 shares, representing a 0.65% stake in Cisco and 1.18% of its equity portfolio. During the quarter, it reduced its position in the stock by 13.41%.
Ken Fisher (Trades, Portfolio) of Fisher Asset Management was second with 20,441,192 shares after a reduction of 2.52%. PRIMECAP Management (Trades, Portfolio) had the third-largest position at 10,507,465 shares after a reduction of 3.71%
Conclusion
There's no doubt Cisco Systems is a financially strong and profitable company, although we might debate its valuation; I'm personally sticking with the modestly undervalued position, for the reasons explained above.
We can also assume the company will continue to face trade and global economic headwinds for some time. Yet, Cisco's management has done a good job of building the company and dominating its market through other headwinds in the past. Good past performance by management is a signal the company will do well in the future.
While the company has debt, value investors may like it for the current pricing and its strong profitability. Growth investors might want to see a price reversal and sustained upward price movement before they jump in. Income investors could give Cisco a closer look, since the combination of the dividend and share buyback history could produce shareholder returns that are above-average.
Disclosure: I do not own shares in any companies named in this article.
Read more here:
- Caterpillar: Following the Global Economy
- Capital One: Should We Buy Before the Price Recovers?
- 5 Guru Stocks Predicted to Boost Earnings
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
