This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Time to sell Cisco?
Selling Cisco (Nasdaq: CSCO  ) -- or downgrading the stock -- is once again in fashion on Wall Street. Yesterday, a good handful of analysts responded to the company's announcement of below-consensus earnings guidance by downgrading the stock. One of them happened to send me an email clarifying why they were no longer hot of Cisco's prospects ... and that's the rating I'll be talking about today.

On Thursday, ace stockpicker Canaccord Genuity removed its seal of grudging approval from Cisco, reducing the stock from "buy" to "hold." The reason had little to do with Cisco's earnings, though. (In fact, Cisco beat consensus estimates for the quarter.) It had more to do with the company's telling investors to expect more trouble in fiscal Q4. But it had most to do with what Canaccord thinks Cisco didn't tell us this week. In particular, Canaccord was hoping Cisco would promise to hit a particular earnings number in 2012.

Promises, promises (please make more)
Cisco didn't do that, of course, saying only that it planned to cut its operating costs by $1 billion. But in Canaccord's opinion, that just leaves one more "shoe" up in the air, waiting to "drop" next quarter -- and presumably stomp any investors so careless as to enter the stock today.

Me, I'm not so sure -- and for two reasons.

Let's go to the tape
First, the analyst's record. Now don't get me wrong. In many ways Canaccord's a fine stockpicker. It's outperforming 95% of the investors we track, after all, but there's one segment of the market in which Canaccord has consistently failed to measure up: communications equipment stocks. Stocks like Cisco:

Company

Canaccord Rating

CAPS Rating
(out of 5)

Canaccord's Picks Lagging
S&P by

Qualcomm (Nasdaq: QCOM  )

Outperform

****

<1 point

Network Equipment

Outperform

***

47 points

Research In Motion

Outperform

**

65 points

Over the five years we've been tracking Canaccord's progress, in fact, it's managed to guess wrong on fully 58% of its Comm-stocks picks -- including the bad bet it made on Cisco's last summer, the one it cashed out on this week. But if you ask me, Canaccord's throwing in the towel too soon on Cisco. I think the stock's drop is setting Cisco up for a bounce of truly monumental proportions.

Could Cisco soar?
Right now, investors are all a-twitter over Cisco's 18% decline in quarterly earnings. Alcatel-Lucent (NYSE: ALU  ) is on a tear. Juniper (NYSE: JNPR  ) and Hewlett-Packard (NYSE: HPQ  ) have swarmed the crucial Internet switches market like a hoard of ravening locusts, devouring Cisco's market share. Riverbed (Nasdaq: RVBD  ) and F5 Networks (Nasdaq: FFIV  ) are trying to rerout the routers business.

The result: Wall Street predicts doom for the company that "built the Internet backbone." And yet, from a pure cash perspective, Cisco is clearly doing just fine. Free cash flow for the past 12 months still sits comfortably north of $9.2 billion, putting the lie to the $7.2 billion in GAAP earnings that so spooked the Street.

Difficult as it may be to believe, the stock's valuation has gotten more attractive in comparison to last quarter, rather than less. At today's prices, Cisco sells for barely 10 times annual free cash flow, meaning in the worst case Cisco is fairly priced for long-term growth of 10%. What's more, if management succeeds in cutting costs by its promised $1 billion, Cisco's only going to get cheaper as time goes on.

Foolish takeaway
Maybe I'm being blind to some obvious defect -- but to me it seems blindingly obvious that Cisco's a bargain. We just have to wait for the rest of the world to realize it.

Fool contributor Rich Smith does not own (nor is he short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 443 out of more than 170,000 members.

The Fool has created a bull call spread position on Cisco Systems and owns shares of QUALCOMM. Motley Fool newsletter services have recommended Cisco Systems and Riverbed Technology as well as a short position in Juniper Networks. 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.


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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 May 13, 2011, at 8:44 PM, cbcon2 wrote:

    I think your assessment is right on target. Tweedy Brown and others agree.

  • Report this Comment On May 17, 2011, at 5:21 PM, jimofcyberland wrote:

    Cisco reminds me so much of another Internet 'blue chip' company I used to own--Sun Microsystems. Of course java, like the networking gear Cisco provides, was the 'backbone' of the Internet in its day. As the company flailed about making mistake after mistake, its market-leading position slowly eroded and then crumbled altogether. Led by a charismatic founder who did not know when to turn the reigns over to the next generation of leaders, these companies do not have the executive oversight to force the hand of the CEO and create the change needed for the company to revive.

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