Boring Portfolio Boring Buys CSCO
June 26, 1996

Cisco Systems, Inc. (NASDAQ: CSCO)
170 W. Tasman Dr.
San Jose, CA 95134-1706

Phone: 408-526-4000
Fax: 408-526-4100
http://www.cisco.com

Closing Price, June 24, 1996: $54
Trade: Buy 100 shares

THE COMPANY

Sometimes folks (including myself) make investing in stocks a lot harder than it needs to be. Foolish founder Tom Gardner has argued steadfastly that even a novice can identify outstanding long-term investments with a "gimme" S&P Stock Guide, a few simple stock-selection rules, and a couple of spare hours. Tom's stock-selection approach is deliberately intuitive -- obvious, even. It emphasizes consistent earnings growth, positive cash flow, healthy profit margins, minimal debt, and the like.

No matter how stringently you set those criteria, one stock invariably makes it over all the hurdles: Cisco Systems.

According to its corporate publicity, Cisco is "the leading global supplier of internetworking solutions, including routers, LAN and ATM switches, dial-up access servers and network management software. These products, integrated by the Cisco IOS software, link geographically dispersed LANs, WANs and IBM networks."

Permit me to interpret that for the non-technoids among us (which includes me). You know that thing called "the Internet"? Well, in their recent book on investing in the Internet, Morgan Stanley analysts Mary Meeker and Chris DePuy estimate that in the next four years, the total business of companies that make the products that constitute the infrastructure of the 'Net will grow to $43 billion: four times its present size. Currently, 80% of that infrastructure has a Cisco label on it (Value Line, June 7, 1996). That's who Cisco Systems is.

So why wrack your brain for investment ideas when Cisco is staring you right in the face? Why, indeed. Apparently the managers of many top-performing growth-oriented mutual funds have reached the same conclusion. Nearly 500 funds control approximately 80% of CSCO shares.

Whoa! Isn't that high level of institutional ownership a potential liability, though? As dominant as Cisco is, no company is immune to an occasional stumble. If (or, more likely, when) that stumble occurs, could not the big funds bail out and leave the individual investor holding the bag? Yup. Indeed, just that sort of thing happened in mid-1994. On the other hand, if you had been buying CSCO shares as the funds were selling then, you would have quintupled your money in the last two years. So if you're going to be caught "holding the bag," having a stack of CSCO in it is not exactly the worst fate in life.

Since going public in 1990, Cisco has rocketed to the very top ranks of NASDAQ-listed companies measured in terms of market capitalization (over $30 billion), right up there with such household names as Microsoft and Intel. Unlike Bill and Andy's excellent companies, however, Cisco remains surprisingly unknown. Indeed, Upside Magazine, a publication which specializes in technology-sector companies and investing, recently tagged Cisco "the most invisible major company in high tech."

Invisible or not, Cisco makes its presence felt. Altogether, Cisco's bought ten companies in the past three years, with six of the acquisitions having taken place since CEO John Chambers took over the helm in January 1995. The most recent of the acquisitions, and also the biggest and perhaps the most important, is StrataCom, Inc. On April 22, Cisco announced it would spend over $4 billion in stock to buy StrataCom, a leader in network switching technology. The market for such switches is expected to quintuple in size by 1998, to $8.4 billion.

With the StrataCom acquisition, Cisco is well-positioned to offer complete end-to-end networking solutions for customers ranging from the kitchen-table entrepreneur to the largest multinational corporation. It's a fair bet that no information systems manager will ever be criticized for selecting Cisco as a vendor.

Cisco's sales are expected to come in around $3.4 billion for the fiscal year ending July 31. That would represent more than a 70% gain over last FY's $1.98 billion. That a company as large as Cisco can grow at such a pace is nothing short of amazing. Partly, it's the result of being in the right place (internetworking) at the right time -- although in no small way Cisco *made* it be "the right time" to be in its business. Partly, Cisco continues to grow so rapidly because, like Hewlett-Packard, another nimble giant, the company has organized itself to think and act like a collection of smaller, yet thoughtfully coordinated, enterprises: small when it wants to be, big when it needs to be -- the best of both worlds.

Late last year, Fortune ranked companies according to their ability to generate wealth from each dollar of capital invested ("Market Value Added"). Cisco took the gold medal in a race of 1,000 companies, with a score of $10.50 in market value produced for every dollar invested -- more than seven times greater than the median score of the 200 biggest companies in the study.

Did I mention that Cisco has zero long-term debt and net profit margins north of 20%?

Cisco also recently took the top slot in Computerworld magazine's list of the best 100 places to work. The company is listed, as well, on the Domini Social Index list of 400 publicly traded U.S. companies screened on multiple social criteria.

Here's some numbers for your crunching pleasure:

Corporate
Performance       1995  1994    1993   1992   1991
Revenues ($Mil)  1978.9 1243.0  649.0  339.6  183.2
Net Profit ($Mil) 421.0  314.9  172.0   84.4   43.2
EPS                0.76   0.60   0.33   0.17   0.09
Net Profit
 Margin (%)        21.3   25.3   26.5   24.8   23.6

Growth Rates(%) 3 yr CAGR 1995   1994   1993   1992
Revenues          79.9   59.2   91.5   91.1   85.4
Profit            70.9   33.7   83.1  103.8   95.3
EPS               66.4   27.7   78.7  101.8   87.5

Quarterly Results     3Q1996   2Q1996 1Q1996 4Q1995
EPS                      0.39    0.34  0.30   0.26

Quarterly Results     3Q1995   2Q1995 1Q1995 4Q1994
EPS                      0.23    0.10  0.19    0.17

Balance Sheet ($Mil)       1995     1994
Cash & Equivalents        204.8     53.6
Inventory                  71.2     27.9
Total Current Assets      996.0    507.7
Total Assets             1757.3   1053.7
Liabilities and Equity
Current Liabilities       337.8    205.5
Shareholders Equity      1378.7    848.2

Cash Flow                  1995     1994
Cash Flow                  0.63     0.49
Capital Expenditures      111.9     59.6

(source: Morningstar)

THE STOCK

A recent article in Investor's Business Daily (5/23/96) noted that Cisco is one of ten technology stocks with: three-year annual earnings growth rates of at least 20%, relative strength and EPS rankings of 80 or higher, share prices above $15, and earnings growth that have fallen within 5% of the stock's three-year average in every rolling 12-month period. In Cisco's case, the company has averaged within four percentage points of 61% annual growth for every rolling 12-month period over the past three years.

IBD rates CSCO 99 on EPS growth, 87 on Relative Strength, and B on accumulation/distribution.

Insiders control approximately 3% of Cisco shares.

CONCLUSION

CSCO is a relatively volatile stock (Beta = 1.79). With opportunities for big reward come some risk. Yet the stock represents an excellent value. At a current price of $54, CSCO is trading at 31-times projected EPS for calendar 1996. Yet the stock is projected to grow EPS at approximately 35% annually over the next five years.

Analysts are looking for $1.44 for FY96 (ending in July), as compared with last year's $0.87 -- i.e., a 66% gain. The current consensus estimate for FY97 is $2.01, or another 40% gain.

It's an honor to have Cisco in the Boring portfolio.

--Greg Markus (MF Boring)


 



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