How many times must a blue chip company report upsetting earnings consecutively before the usually temporary post-results dip in the share price becomes a permanent loss? For Cisco Systems (CSCO), the magic number seems to be three. And then Cisco’s fourth consecutive negative earnings surprise merely sent the stock to new depths.
Indeed, Cisco shares now trade lower than ever on both earnings and sales comparisons. The stock is either an incredible bargain or an investment sure to keep sliding. The research community is particularly divided on the future fortunes of this company, a $99.02 billion (market cap) member of the Dow.
YCharts Pro says the shares are attractive and undervalued, both because of Cisco’s strong balance sheet and a share price out of line with the sector and its own traditional trading levels. A look at the factors behind the company’s recent unpleasantness gives more credence to that bargain theory.
Cisco’s core business is selling the things that make the Internet run. This includes switching systems, high-speed routers and data security systems bought by governments, internet service providers and large corporations.
The current fiscal problems of these big customers, particularly governments, have been key in Cisco’s recent revenue and earnings slides. Its consumer products division, a much smaller but formerly growing part of the company, also helped drag down the revenue figures.
The debate over whether Cisco is worth buying now, however, centers largely around concerns about its profit margins.
Is this lower level of return a temporary result of general economic weakness? Or is it a new reality for a company facing growing competition?
Cisco’s critics have made much about the rise of its competitors in the core switches business, particularly Juniper Networks (JNPR). Juniper’s revenues are growing, probably at Cisco’s expense. Competition on price for customers with Juniper does not bode well for Cisco’s profit margins, as Juniper can eat a few margin points and still best Cisco.
Cisco management has vowed to solve its problems, both with the wary investment community and its internal operations. The company announced its first-ever Cisco dividend
One of those moves may be selling off consumer businesses Cisco acquired in recent years. Some of those acquisitions seemed particularly off-target anyway, such as its purchase of Flip video camera maker. Sales of consumer businesses would both raise the company’s profit margins and refocus attention on its core business, where Chambers says he can cut costs.
The idea that Cisco’s competitors will suck away substantial portions of its customer base any time soon seems a little hyped up. Juniper and several others are making inroads, but Cisco is still the largest provider of routers and switching equipment by a gargantuan margin.
Cisco’s reputation and experience with the biggest buyers in the market will go a long way toward keeping those customers even when pitted against the Junipers of the sector. It’s not the kind of product that always goes to the lowest bidder. In fact, Cisco seems destined for a rebound in its core business once the current financial crisis subsides, when those big buyers find they cannot put off technology upgrades any longer.
The price of Cisco shares now makes it worth buying and waiting out the few quarters it should take the company to turn it around. With its price at historic lows, a large gain in sales or profit margins shouldn’t be necessary to make money on the shares.
There’s logic in the age-old advice to steer clear of people that consistently disappoint. (“Fool me once, your fault. Fool me twice, my fault.”) But in this case, disappointment just makes for a buying opportunity.
Dee Gill is an editor for the YCharts Pro Investor Service.
