How to Play Cisco in 2011

Each year, we take a look back in order to look ahead. We do this by industry, by trend, and ultimately by stock. Here's a closer look at Cisco (Nasdaq: CSCO  ) , Fool style.

Foolish facts

Metric

Cisco Systems

CAPS rating (out of 5) ****
Total ratings 10,057
Percent bulls 95.4%
Percent bears 4.6%
Bullish pitches 1,467 out of 1,553
Highest rated peers Digi International, Spirent Communications, Network Engines

Data current as of Dec. 29.

Has the world turned upside down? Once one of the tech industry's great growth stocks, data networking leader Cisco has become a darling of value investors. Fools think the stock is cheap on an absolute and historical basis.

A mid-November haircut helped draw in the cheapskates. The networker's shares dropped more than 10% after reporting strong quarterly results that apparently weren't strong enough. Call it Wall Street suffering a severe case of stupid.

"While the estimates are a little fuzzy at the moment, after a 16% single-day drop I really don't think you can overestimate [Cisco] too much going forward. I'm not really in love with [Cisco] as a company, but on a cash basis the stock is cheap. Sub $19 this is a steal," wrote Foolish investor JustHanginOut in response to a late November pitch by CAPS All-Star JakilaTheHun.

Looking back to look forward
Value hounds would agree, even if the year's big Cisco stories at Fool.com reveal a mixture of hope and skepticism:

  • The year began with a confident Cisco ending its long-standing systems integration partnership with Hewlett-Packard (NYSE: HPQ  ) . The company's unified computing systems would replace the need for independent servers from the likes of HP -- or so the thinking went.
  • In March, Cisco introduced the CRS-3 to improve the speed and delivery of petabytes of data between the data centers that comprise the backbone of the Internet. AT&T (NYSE: T  ) expressed enthusiasm for the new hardware.
  • Cisco would report strong earnings and revenue gains two months later. But as my Foolish colleague Anders Bylund pointed out at the time, in neither metric was Cisco growing faster than its closest competitors, Juniper Networks (Nasdaq: JNPR  ) and Brocade Communications Systems (Nasdaq: BRCD  ) .
  • In what it could become a $40 billion opportunity, Cisco in June finished the data infrastructure for the hyper-connected city of New Songdo, South Korea. Winning similar contracts won't be easy; IBM (NYSE: IBM  ) has also positioned itself as an infrastructure supplier for the next generation of smart cities.
  • Later that month, Cisco announced plans for a business-savvy, Android-powered tablet computer called the Cius. If Apple wants the iPad to take over the enterprise in 2011, it'll have to get past Cisco and the Cius.
  • But Apple isn't the biggest competitive threat to Cisco. Far from it. In July, HP announced Avaya as the latest in a string of new communications partnerships aimed at taking business from Cisco.
  • In August, Cisco once more disappointed investors by not pummeling Wall Street's earnings expectations. (Sense a theme here?)
  • The next month, HP fired another salvo in its war with Cisco by announcing that its six major data centers had abandoned Cisco technology in favor of its own networking products. Ouch.
  • October brought more bad news. Cisco stubbed a toe by mispricing its consumer videoconferencing device, the Umi Telepresence, at $600.
  • The year would end with a whimper when, this week, broadband rival Arris Group (Nasdaq: ARRS  ) poached talent from Cisco that should help the upstart maintain a healthy partnership with Comcast.

And throughout all that, here's how Cisco fared financially:

Fiscal 2010-2011 Performance

Q2 2010

Q3 2010

Q4 2010

Q1 2011

Revenue growth 8.0% 27.0% 27.0% 19.2%
Normalized net income growth 19.7% 39.2% 51.5% 6.0%
Gross margin 64.5% 63.9% 62.7% 62.8%
Return on capital 11.1% 10.2% 9.7% 9.9%

Source: Capital IQ, a division of Standard & Poor's.

And here's what analysts expect from Cisco over the next two years, according to data compiled by Capital IQ:

Capital IQ Estimates

2011

2012

Revenue estimate $46,129 million $49,900 million
Normalized profit per share estimate $1.72 $1.87

Source: Capital IQ, a division of Standard & Poor's. Data current as of Dec. 29.

Foolish outlook: bearish
As much as I want to believe in Cisco at current prices, I think fellow Fool Andrew Bond has a point. The company often appears directionless. A good valuation is only as good as the growth it assumes, and we may be assuming too much in Cisco's case.

So, should you avoid Cisco altogether? No. A better strategy is to hedge. Cisco might have problems, but it's beaten down enough that I don't see the bottom falling out of its share price. Sell Cisco puts, collect the premium, and wait to see if management's arm-waving leads to a price too low to ignore. (Click here for more about options-driven strategies such as selling puts.)

Now it's your turn to weigh in. What do you think of Cisco's prospects at current prices? Use the comments box below to explain your thinking. You can also rate Cisco in Motley Fool CAPS.

What will be next year's best stock? The Motley Fool has created a brand new free report called "The Motley Fool's Top Stock for 2011." In it, we reveal the little company set to profit from the broadband Internet expansion. Get instant access by clicking here – it's free.

Interested in more info on the stocks mentioned in this story? Add Cisco, Hewlett-Packard, Juniper Networks, Brocade Communications Systems, IBM, Apple or Arris Group to your watchlist.

Apple is a Motley Fool Stock Advisor selection. Juniper Networks is a Motley Fool Big Short short-sale pick. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He had stock and options positions in Apple and a stock position in IBM at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Motley Fool Alpha owns shares of Cisco and has a short position in Juniper Networks. The Motley Fool owns shares of Apple and IBM, and has created a bull call spread position in Cisco. The Fool is also on Twitter as @TheMotleyFool. When it comes to stocks, its disclosure policy is a lookie-loo.


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