Cisco Slaughtered by Wall Street Stupidity

Cisco (Nasdaq: CSCO  ) fell 12% after hours yesterday, despite reporting earnings that beat expectations. Now, I don't follow the company at all -- couldn't even tell you what it really does -- but this caught my attention. How can a company beat expectations and still be an epic disappointment?

Most who follow the company blamed a dire outlook. I'd like to believe them. But I found this line, quoted from an analyst we'll leave unnamed, both candid and amusing: "The Street was expecting a bigger beat."

Gah. If there's a bigger oxymoron than expecting earnings to beat expectations, I'm stumped. Quick sanity check: If you're expecting a surprise, it's not a surprise.

What's scary about this form of Wall Street stupidity is the effect it has on companies. If management's job is to please shareholders, and shareholders play silly games, then games are what management will deliver. Roger Lowenstein explains in the book Origins of the Crash how the relentless pressure to beat expectations can make otherwise good companies bend:

Number games were becoming a pervasive part of the culture [in the '90s]. The total of companies forced to restate earnings because of accounting errors rose from a handful a year in the early '80s to more than 150 a year by the late '90s. And restatements only scraped the surface; most companies, including IBM (NYSE: IBM  ) , were clever enough to manipulate the numbers without running awry of the rules. Microsoft (Nasdaq: MSFT  ) flatlined results by deferring (until, presumably, a rainy day) billions of dollars in revenue. PepsiCo (NYSE: PEP  ) resorted to the well-known artifice of a "big bath" -- a one-time charge that would enable it to report higher quarterly earnings in the future. According to an intriguing study, the number of companies that either met or just topped their previous quarter's earnings far surpassed the number that fell just a penny short -- a result inconsistent with mathematical chance.

Sad. Warren Buffett, whose honesty has made Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) one of the world's most successful corporations, once said, "We won't 'smooth' quarterly or annual results. If earnings figures are lumpy when they reach headquarters, they will be lumpy when they reach you."

That's how you beat shareholders' expectations.

Fool contributor Morgan Housel owns shares of Microsoft and Berkshire Hathaway. Berkshire Hathaway and Microsoft are Motley Fool Inside Value recommendations. Berkshire Hathaway is a Motley Fool Stock Advisor pick. PepsiCo is a Motley Fool Income Investor pick. The Fool has written calls (Bull Call Spread) on Cisco Systems. Motley Fool Options has recommended a diagonal call position on Microsoft. Motley Fool Options has recommended a diagonal call position on PepsiCo. The Fool owns shares of Berkshire Hathaway, International Business Machines, and Microsoft. 

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (29) | Recommend This Article (68)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 11, 2010, at 9:17 AM, techy46 wrote:

    Here we go again. Who appointed CISCO (Chambers) as a proxy for the Tech sector? They sell hi-end network components which represent less than 10% of the consumer and enterprise network architecture. CISCO, Chamber's predictions for the tech sector were totally wrong last quarter and they're wrong this quarter. Apple, AT&T and BestBuy are good consumer tech barometers and IBM, Intel and Microsoft are good enterprise barometers. CISCO is a contrarians delight that the bears and short love to use to create volatility and trading opportunities for options. CISCO sucks. The .com bubble is over.

  • Report this Comment On November 11, 2010, at 11:26 AM, 1020chicago wrote:

    The writer says" Now, I don't follow the company at all -- couldn't even tell you what it really does .." Later the writer quotes Warren Buffet. Maybe the writer should follow Warren's lead, " I don't speak about or invest in businesses I don't understand." Warren said this when he was asked about investing in technology companies. It is clear the writer has no understanding of the technology business as well as Cisco setting the standard for continually beating earnings throughout its history by 2-3 cents. Of course any company who beats earnings every quarter by a consistently reliable number is going to set expectations. Cisco is NOT a bellweather for technology anymore. Only CNBC and those unfamilair with technology innovation miss this point. Cisco is losing market share to other companies in key growth areas, Wireless LAN, Acceleration, Security and Load Balancing for example. Further huting Cisco is its recent jump into lower margin business including: servers in the enterprise and consumer based products. Cisco reminds me of the Germans in WWII. They tried to fight everyone on multiple fronts. That is a losing strategy since everyone eventually becomes your enemy. Cisco will contoiue to grow in a growing market, but at a slower pace than those innovative companies taking it market share in multiuple segments. Cisco is fairly valued at a PE of 12 and that number assumes Cisco starts paying an increasingly growing dividend.

  • Report this Comment On November 11, 2010, at 2:22 PM, stan8331 wrote:

    Cisco's quality as a company is irrelevant to the author's point here. If Cisco is a bad company, they were a bad company BEFORE they beat the quarterly earnings estimate and saw a double-digit drop in the stock.

    When they get pushed into playing the quarterly earnings game, companies end up doing things that are not in their long-term interest. The only folks who win in that scenario are the short-term traders. Management, long-term shareholders and employees all lose.

  • Report this Comment On November 11, 2010, at 4:37 PM, cpriewe wrote:

    Hey Fools! Another example is Boeing A 95 dollar stock now selling for $65 because on a test flight, of the new Jumbo Jet, a wire got hot and caused the cockpit to smell of smoke !

  • Report this Comment On November 11, 2010, at 5:29 PM, ps56k wrote:

    ok - the author states that he doesn't know about Cisco or what it does ! AMAZING - I stopped reading the article at that point. What a moron - to pen an article about a company he has no idea what they do or the impact they have on the world - yet he wants us to follow his words, logic and numbers....

    Have never posted here on Motley - but this kinda colors all my future readings as just some guy in his mom's basement...

  • Report this Comment On November 11, 2010, at 5:34 PM, TMFBrich wrote:

    @ps56k,

    Read the rest of the article. I think you'll be satisfied with the perspective it provides.

    Brian Richards

  • Report this Comment On November 11, 2010, at 7:06 PM, midnightmoney wrote:

    I'd agree with TMFBrich, I found the article's logic flawless, and the point argued from principle. If you were a tennis teacher and overheard someone say he always runs around his backhand, you'd cringe and wouldn't have to see the dude play to know he wasn't playing the game as he should. Same idea at work here, I think. I like the article. And I like tennis. Ad in the fool!

  • Report this Comment On November 11, 2010, at 10:38 PM, Ozcutty wrote:

    The stock market is forward looking .i.e. what you will earn in the future is more important than the last qtr. Despite 100% gains in some markets, Cisco is being dragged down by its size.

    Looks like becoming a slow growing dividend stock in the future.

    Still a good investment at the right price, after all they do have 38billion in cash!

  • Report this Comment On November 12, 2010, at 12:18 AM, JBivins wrote:

    Everyone jumping on this guy’s story because he said he didn’t follow Cisco is mentally retarded. He just said that because maybe, unbeknownst to him, there is a justified reason that Cisco lost 12% in market value, but in actually it is due to the stupidity of the stock market and short term traders. Cisco beat its expected earnings yet it somehow it still lost over 10 billion in market value, and THAT ladies and gentlemen is stupid. I pretty sure that was what the author was hinting at. But some people here are to far stuck up their own butts that they can’t see that.

  • Report this Comment On November 12, 2010, at 1:23 AM, mattmcneil wrote:

    To say "Wall Street is stupid" is itself a moronic comment. Obviously the smart money -really- didn't like what they saw and the guidance/surprise provided by Chambers. Lord knows retail investors didn't move this stock that much with that volume.

    This article was clearly written by a Fool employee who himself doesn't hold a position in CSCO but the company must have lost a ton of $ on their call options (which were disclosed at the bottom of the article - kudos for that) and so they are trying to talk the stock back up and using this chap as their messenger.

    In the end Fool - I have to say i'm seeing more articles like this (explicitly trying to talk up your own investments) and i'm starting to see alot more bias in your articles - bias that is slowly replacing logic. (Any article on RIMM comes to mind - a company making $ hand over fist, record quarter after record quarter yet constantly talked down - why? Fool is long Apple)

    My advice? Remember - if anyone says "the market is stupid" it usually means they are unable to come to terms with the fact that the market knew something that they did not and took them by surprise.

    Another piece of advice. Your readers aren't as dumb as you think. Most of your readers can sniff out the self-serving articles. And they are increasingly frequent as of late.

  • Report this Comment On November 12, 2010, at 1:26 AM, Cleveland51 wrote:

    It must be just me but this article seems to be about analyst's expectations and the effect expectations have on companies. Mr. Housel could have replaced CISCO with "Amalgamated Widget International, Inc." and the point of the article would have been the same.

  • Report this Comment On November 12, 2010, at 1:37 AM, mattmcneil wrote:

    Further to my point on self serving bias replacing logic - take this excerpt from the headline article in yahoo finance: "The computer network equipment maker said its revenue will rise by less than half of what analysts had predicted for its November-through-January quarter. There are worries that smaller competitors are cutting into Cisco's market share."

    Less than half of what analysts predicted. That's a big miss. Kinda hard to take the Fool author seriously when they start the article with: "How can a company beat expectations and still be an epic disappointment?"

  • Report this Comment On November 12, 2010, at 9:07 AM, jetamerica wrote:

    I prefer to use dramatic declines as a market tool. Not to create positions but to add to favored positions. CSCO beat expections for the quarter, but reduced its projections for the next-while still growing for the quarter. My belief is that the decline was greatly overdone so I added to my position at 16% below the prior day . They lead their segment, have about $7 cash per share, generate mountains of cash, shareholder equity incraesed about 30% over the last three years, are a global play. I love it when analists cause exagerrated declines IF the fundamentals remain sound. Investors see such sharp declines as an opportunity versus the short term trader mentality.

  • Report this Comment On November 12, 2010, at 9:23 AM, dfrizzle03 wrote:

    @mattmcneil

    "To say "Wall Street is stupid" is itself a moronic comment. Obviously the smart money -really- didn't like what they saw and the guidance/surprise provided by Chambers."

    i guess we should follow smart money, that would have done us good with mortgage backed securities and/ or funds. don't pay attention to "smart money" because whether the money is smart or stupid, that money is still affected by human biases and irrationalities.

  • Report this Comment On November 12, 2010, at 11:15 AM, TMFRhino wrote:

    "i guess we should follow smart money, that would have done us good with mortgage backed securities and/ or funds. don't pay attention to "smart money" because whether the money is smart or stupid, that money is still affected by human biases and irrationalities."

    +1, good stuff.

  • Report this Comment On November 12, 2010, at 12:43 PM, langco1 wrote:

    this is a great chance to buy stock in csco near a 52 week low! you dont often get a chance to buy a big name blue chip like this on sale!

  • Report this Comment On November 13, 2010, at 2:40 AM, mattmcneil wrote:

    @ dfrizzle03 - Your comment seems to only take exception to usage of the term "smart money" and ignores my main point which is TMF bias.

    By "smart money" I mean the money which is privy to early/insider information that retail investors don't have access to and hence drive market direction and sentiment.

    Here's a plausible theory on what happened: Smart money (see definition above) knew of the forthcoming massive disappointment on future guidance. (revised by more than 50% downwards - that's some big 'air pocket' from out of nowhere, Mr Chambers) They got out of dodge in a hurry. Even before it was actually "officially" out of Chambers' mouth. Your bewildered TMF author along with retail investors were left scratching their heads because they were looking at the most recent earnings, which were fine. Whisper info like this circulates all the time in institutional investment circles. It's one of their strongest advantages over retails folks. They are the ones that have the access to CSCO executives - not you and me.

    Now does a theory like that seem to make a little more sense than saying "I don't know or follow CSCO at all but the market is stupid"??

    18% declines with exceedingly high volume over 2 consecutive days on a blue chip company that just beat on its recent earnings is not stupidity. It's smart money telling you that they had information before you did and that information was very very bad.

    @ TMFRhino - Good point. I know you mustn't like it when your colleagues are being challenged but at least please try to have a point. You are presumably being paid to contribute to these forums after all.

    Like ps56k, I rarely, if ever am compelled to comment on here but this was such a really weak article. No point whatsoever other than to talk up the shares that TMF owns. Smarten up Motley Fool.

  • Report this Comment On November 13, 2010, at 10:21 AM, TMFHousel wrote:

    "This article was clearly written by a Fool employee who himself doesn't hold a position in CSCO but the company must have lost a ton of $ on their call options (which were disclosed at the bottom of the article - kudos for that) and so they are trying to talk the stock back up and using this chap as their messenger."

    "No point whatsoever other than to talk up the shares that TMF owns. Smarten up Motley Fool."

    Folks, not one word of this article talks up Cisco's shares.

  • Report this Comment On November 13, 2010, at 12:35 PM, justasking999 wrote:

    Isn't Cisco's guidance more empirical evidence of deflation, that economists and the Fed have been warning about for the last several months? Isn't it true that Cisco's results are not reflective of a loss of market share, but are rather reflective of the same market share, but of a smaller market, due to falling demand, which in turn puts deflationary pressure on prices and margins?Now we are seeing how deflation impacts stock prices, equity, and market capitalization.

  • Report this Comment On November 13, 2010, at 6:17 PM, compufixer wrote:

    I thought the Fool had written,not bought the call options.

  • Report this Comment On November 14, 2010, at 2:55 PM, mattmcneil wrote:

    @ TMFHousel - Writing an article that incorrectly attributes the 18% sell off to "wall street stupidity" while not ONCE mentioning the real reason for the stock falling off a cliff: that they suddenly revised guidance on their NEXT quarter down by over 50% (completely out of the blue - I might add) is one of two things (and neither paint you and your colleagues in a flattering light):

    1. Tremendous ignorance on the stock in question. If you don't know what is moving a stock don't write the article!

    2. Motley Fool intentionally offering a pathetic theory for the sell off (Wall St. is stupid) so your readers don't focus on the very real and very bad cause of the sell off (a disastrous earnings revision) and continue the selling. That's an attempt to talk the stock back up.

    @compufixer - Good question. However their disclosure is for a "Bull Call Spread" which is a Bullish options strategy. They lost big on their CSCO options since they anticipated the stock to go up.

  • Report this Comment On November 14, 2010, at 3:17 PM, mattmcneil wrote:

    My mistake. There was one passing reference to the real cause of the selloff: "Most who follow the company blamed a dire outlook. I'd like to believe them."

    Of course as expected it's a very passing reference (9 words) and then immediately discredited with the following sentence: "i'd like to believe them."

    It all adds up to you guys trying to manipulate retail investors actions in order to benefit your own positions.

  • Report this Comment On November 14, 2010, at 7:43 PM, TMFHousel wrote:

    "It all adds up to you guys trying to manipulate retail investors actions in order to benefit your own positions."

    What positions TMF owns has exactly 0% influence on what I, or any TMF contributor, write. I've been equally criticized for writing negatively about other companies our services recommend.

    I'm sorry to hear of your constant displeasure. If you firmly believe we're nothing but a conspiracy trying to front-run our positions, I don't know how much you'll benefit from our services and articles. Or any others.

  • Report this Comment On November 15, 2010, at 10:57 AM, mattmcneil wrote:

    It's not "constant displeasure" and please don't try painting me as a conspiracy theorist as your last resort. I'm just calling you out on it this time. As I said in my first post, this is happening with increased frequency. I've been faithfully reading articles on here for a very long time now but they are slowly starting to fail the sniff test a little too often. This one was a particularly good example.

  • Report this Comment On November 15, 2010, at 11:02 AM, TMFHousel wrote:

    mattmcneil,

    OK, we'll have to agree to disagree. In the future, how would you recommend we handle writing about companies TMF has a position in?

  • Report this Comment On November 15, 2010, at 12:45 PM, mattmcneil wrote:

    I guess keep up with the disclosures and when another article smells as bad as this one does you'll find out in the comments section if you haven't disguised it well enough again.

    Other than that - focus on relevant issues driving a stock. And if you think a surprise downward revision for the very next quarter of more than 50% is not very relevant then I can't help you.

  • Report this Comment On November 15, 2010, at 12:51 PM, TMFHousel wrote:

    Matt, there's nothing to disguise. TMF's positions have absolutely no influence on what I write.

  • Report this Comment On November 19, 2010, at 3:51 PM, HurricaneJohnson wrote:

    Yes, the topic happened to use Cisco as the example to make a point. No more, no less. If you look at the history of Cisco's competitors over the last 12 years, you'll see that many of them have either gone away or have pulled out of Cisco-dominated portions of the marketplace. There is a market for high-end networking and Cisco just happens to dominate it in most categories.

  • Report this Comment On November 21, 2010, at 12:43 PM, aleax wrote:

    @ozcutty, I agree that CSCO's becoming a good, "stalwart" dividend play.

    I love getting into "former fast growers" around the time their growth stabilizes as they turn into stalwarts (ideally dividend-paying ones) -- that's when the market, which previously overpaid for their earnings (high P/E, sometimes to insane heights such as CSCO's 2000 numbers -- stock peaking at 80 with trailing earnings/share of 0.62, i.e. P/E almost 130, vs today's 14.38 P/E [forward P/E today 10.66, but forward P/E is something of a smoke and mirrors idea anyway;-)]), suddenly switches into a mode of undervaluing them instead.

    INTC is of course the prime example today, but CSCO seems to be bidding fair to become another soon -- so I just started a position (via selling puts at 20, which were of course just assigned) for it to join my "stalwarts" sub-portfolio, next to INTC, MDT, WMT, ... (I *do* understand CSCO's business pretty well: after all, high-tech, and networking in particular, ARE my daily job;-). Overall, I agree with ValueLine's take on CSCO (not an unusual thing, for me to agree with ValueLine;-) which sees it going to the 35-to-45 range in a 3-5 years time frame -- doubling in 4 years means almost 20% annualized returns, which in addition to the likely-forthcoming dividend (presumably within 2011), and the small but steady income you can make by selling well-out-of-the-money covered calls ("losing" -- actually taking 10% capital gains in 3 months;-) -- only if called on an unexpected surge), makes it a good, steady (safety rank 1 per VL;-) stock for my "stalwarts" sub-portfolio...!

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