Cisco: Deep Value or Value Trap?

The bigger they grow, the harder they fall. But sometimes they bounce back with a vengeance.

Cisco Systems (Nasdaq: CSCO  ) is in the falling part of that cycle. Just over a year ago, the networking giant was on top of the world with a market cap north of $150 billion and 50% of one-year share price gains behind it. Then the wheels fell off this careening stock, merely "good" earnings reports stopped exciting investors, and the share price has been just about cut in half since that peak. What's more, Cisco keeps exploring new 52-week lows on a regular basis.

After pushing Cisco through our Inside Value service's discounted cash flow valuation tool, the stock looks outrageously cheap. Assuming that Wall Street analysts have a clue about Cisco's growth prospects, adopting their 10% five-year growth estimate puts Cisco's intrinsic value at nearly $29 per share -- almost double the current price.

Dial down the growth expectations to 3% a year, just keeping pace with inflation, and you still get a 24% margin of safety. You have to assume Cisco's cash flows growing at a minuscule 0.5% a year from here to eternity in order to arrive at today's actual share price and market cap.

Deep value or value trap?
So there is no question that Cisco is cheap today. In fact, it's considerably more affordable than fully mature mastodons ExxonMobil (NYSE: XOM  ) and Wal-Mart (NYSE: WMT  ) on key metrics such as forward price-to-earnings (In Wal-Mart's case) and EV/EBITDA (In Exxon's case). You know you're in the deep-discount value bin when those guys look ritzy.

That doesn't necessarily mean you should back up the truck and mortgage your house again just to take advantage of this tremendous value. If Admiral Ackbar were here, he might give cry to his immortal warning: "It's a trap!"

If Cisco has any spark left in it at all, we're looking at a great value. But it's a classic value trap if you believe that this company has seen its peak already, and that the future might involve more shrinkage than growth.

Guidance, please!
Cisco CEO John Chambers admits that his company has problems and vows to fix 'em all. Exactly how, I'm not sure, though the new Cisco is sure to contain a smaller dose of consumer products. The Flip video camera division has already met its maker, for example. The Linksys line of consumer-friendly networking tools and the Scientific-Atlanta cable TV systems might soon have new masters -- or none at all.

Dropping these frivolous additions -- all brought to Cisco by a series of acquisitions rather than internal development -- might be the correct thing to do now. The real issues started elsewhere, though, when Cisco decided to sell its own server hardware in direct competition with IBM (NYSE: IBM  ) and Hewlett-Packard (NYSE: HPQ  ) . Former bosom buddies and reseller partners quickly became heated rivals. And now it's way too late to really fix what ails Cisco.

That strategic error is what keeps my portfolio firmly separated from Cisco stock. The servers may be selling all right these days, but that small victory wasn't worth the damage the same products caused to Cisco's time-honored partnerships and reputation for close customer support.

The incredible shrinking Cisco giant looks like a very plausible reality. There are many competitors ready, willing, and able to fill Cisco's roomy shoes, including all-around rival Juniper Networks (Nasdaq: JNPR  ) , storage networking specialist Brocade Communications Systems (Nasdaq: BRCD  ) , and other optical networking experts.

And I mean that both in terms of revenue share and investing opportunity. Cisco may be cheap, but sometimes you get exactly what you pay for. The real wealth-building champs are found elsewhere in the tech sector. Read this free report to see five stocks the Fool owns in real-money portfolios, including two high-tech superstars that could belong in your own portfolio.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. The Motley Fool owns shares of Wal-Mart and IBM. The Fool owns shares of and has created a bull call spread position on Cisco. Motley Fool newsletter services have recommended buying shares of Wal-Mart and Cisco. They have also recommended creating a diagonal call position in Wal-Mart Stores and shorting Juniper Networks. 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. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


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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 June 28, 2011, at 1:13 AM, Brettze wrote:

    Maybe Intel and Cisco will merge ??

    Intel can die shrink Cisco or turn Cisco into a new optically networking powerhouse! There is always new technology just around the corner that will surprise you like there i s no yesterday. Intel is vigorously working on optics to speed up its chips and it is logical to move up the food chain into Cisco 's servers and routers making it so lightinig fast! Cisco and Intel has plenty of cash to overhaul the stale technology we are having today!

  • Report this Comment On June 28, 2011, at 1:14 AM, Brettze wrote:

    Cloud computing will never be the piddlingly slowly same again ever!

  • Report this Comment On June 28, 2011, at 1:14 AM, Brettze wrote:

    Look at the future not the balance sheet of last quarter!~

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