Here's How Cisco May Be Failing You

Margins matter. The more Cisco Systems (Nasdaq: CSCO  ) keeps of each buck it earns in revenue, the more money it has to invest in growth, fund new strategic plans, or (gasp!) distribute to shareholders. Healthy margins often separate pretenders from the best stocks in the market.  That's why I check on my holdings' margins at least once a quarter. I'm looking for the absolute numbers, comparisons to sector peers and competitors, and any trend that may tell me how strong Cisco's competitive position could be.

Here's the current margin snapshot for Cisco and some of its sector and industry peers and direct competitors.

Company

TTM Gross Margin

TTM Operating Margin

TTM Net Margin

 Cisco

63.5%

22.5%

18.9%

 NetApp (Nasdaq: NTAP  )

64.4%

14.7%

12.4%

 Brocade Communications (Nasdaq: BRCD  )

58.9%

10.1%

5.7%

 Echelon (Nasdaq: ELON  )

43.3%

(25.2%)

(26.1%)

Source: Capital IQ, a division of Standard & Poor's. TTM = trailing 12 months.

Unfortunately, that table doesn't tell us much about where Cisco has been, or where it's going. A company with rising gross and operating margins often fuels its growth by increasing demand for its products. If it sells more units while keeping costs in check, its profitability increases. Conversely, a company with gross margins that inch downward over time is often losing out to competition, and possibly engaging in a race to the bottom on prices. If it can't make up for this problem by cutting costs -- and most companies can't -- then both the business and its shares face a decidedly bleak outlook.

Of course, over the short term, the kind of economic shocks we recently experienced can drastically affect a company's profitability. That's why I like to look at five fiscal years' worth of margins, along with the results for the trailing 12 months (TTM), the last fiscal year, and last fiscal quarter (LFQ). You can't always reach a hard conclusion about your company's health, but you can better understand what to expect, and what to watch.

Here's the margin picture for Cisco over the past few years.

Source: Capital IQ, a division of Standard & Poor's. Dollar amounts in millions. FY= fiscal year. TTM = trailing 12 months.

(Because of seasonality in some businesses, the numbers for the last period on the right -- the TTM figures -- aren't always comparable to the FY results preceding them.)

Here's how the stats break down:

  • Over the past five years, gross margin peaked at 65.8% and averaged 64.3%. Operating margin peaked at 25.1% and averaged 23.5%. Net margin peaked at 21% and averaged 19.5%.
  • TTM gross margin is 63.5%, 80 basis points worse than the five-year average. TTM operating margin is 22.5%, 100 basis points worse than the five-year average. TTM net margin is 18.9%, 60 basis points worse than the five-year average.

With recent TTM operating margins below historical averages, Cisco has some work to do.

If you take the time to read past the headlines and crack a filing now and then, you're probably ahead of 95% of the market's individual investors. To stay ahead, learn more about how I use analysis like this to help me uncover the best returns in the stock market.  Got an opinion on the margins at Cisco? Let us know in the comments below.

Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. The Fool has written calls (Bull Call Spread) on Cisco. 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 (2) | Recommend This Article (5)

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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 30, 2010, at 9:40 PM, noahchilly wrote:

    Not sure what you're getting at, CSCO is operating at a terrific profit and has an RSI now less than 30, indicating that it is oversold. The stock price has recently dropped 20% and the company is debt free, invested heavily in R&D, the coming cloud revolution, and has plans to buyback shares, offer a dividend... The title of your article doesn't make sense, as an investor of CSCO, I am using the current fear to buy more shares on the cheap, so what if margins have changed by less than 1%? I think CSCO is a tremendous value play right now.

    Long CSCO and adding to my client's positions.

  • Report this Comment On November 30, 2010, at 10:13 PM, Usnzth wrote:

    CSCO has a ROE of 18.6% and a current P/E under 11.5. Compare that to a P/E over 26 just eight months ago, and an avergae P?E over the past three years of about 18. It's EPS has risen nearly 30% in the last year.

    The CEO owns over 2.5 million shares, and the company is constantly improving. The last earnings report was a smackdown that now screams BUY!

    Over the short term, the market is a voting machine. Over the long term, it is a weighing machine.

    Long CSCO call options and buying more if it drops to $19.00

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