Is Cisco the Best Value on The Dow Today?

Dow component Cisco is undervalued. Here's why.

Jun 17, 2014 at 1:00PM
Take The Long View

The Dow Jones Industrial Average (DJINDICES:^DJI) was down 18 points in early afternoon trading on Tuesday as financial media coverage continued to ask how high this bull market could go.

Whether the Dow continues its run or takes a summer hiatus is really insignificant to all the value investors out there. What matters in the value world is finding stocks that are trading for less than their real value. Companies like Cisco (NASDAQ:CSCO).

The value play
I've written recently about how I identified Cisco as a potential value investment target (for the step-by-step guide on exactly how to do this, click here).

The tl;dr (too long; didn't read) version is pretty straightforward. First, Cisco's profit-to-enterprise value ratio is way above average, meaning that its market price-to-earnings ratio is attractive relative to the rest of the market. Second, its return on shareholder capital is also way above average, meaning there is a strong return on investment potential over the next several years.

The next question, then, is why is Cisco undervalued? What does the market know that we don't?

A simplistic peer comparison
Let's start by comparing Cisco's price-to-earnings ratio with some of its main competitors -- noting that Cisco is in the poll position in the networking industry.

Company P/E (TTM)
Cisco 16.5
Hewlett-Packard 12.3
Juniper Networks 28
Alcetal-Lucent N/A

Cisco has a market cap of $125.6 billion, dwarfing Juniper Networks' (NYSE:JNPR) $11.9 billion and nearly doubling Hewlett-Packard's (NYSE:HPQ) $65.1 billion.

Hewlett-Packard is not a pure comparison, with consumer-facing computing being the company's primary business. Network hardware remains a niche division.

Alcatel-Lucent (NYSE:ALU) posted negative earnings of $0.56 per share on a trailing 12-month basis. The $10 billion market cap company has a gross margin below its peers, negative revenue growth year over year, and a paper-thin 2% operating margin.

Juniper Networks is a pure network company comparison, and it is the only company with quarterly revenue growth year over year. It is this growth, which was 11% for the most recent quarter, that is driving its P/E ratio to such a high level.

The picture, as of now, is of industry giant Cisco losing market share to an upstart competitor while fighting for its lunch against HP and other household names. It's a picture of an entrenched incumbent, suddenly out of favor in the markets as other, shinier, high-growth competitors steal the spotlight.

When others are fearful, be greedy
Over the last year, Juniper Networks' stock has risen 32%. Cisco's has risen just 1.7%.

CSCO Chart

CSCO data by YCharts.

Why? My guess is that Juniper is new and shiny, while Cisco is old and dull. So old and dull that the market has forgotten what a great company Cisco is.

I could be wrong on the reason, of course, but the numbers speak for themselves. Cisco's quarterly revenue has grown 35.7% over the past five years, nearly matching Juniper's 42% growth. 

How does that revenue translate into profit? Cisco has an operating margin of 20% on a trailing 12-month basis. That compares to just 9.9% at Juniper. Over the past five years, Juniper's margin has actually shrunk by 34% while Cisco's has remained essentially constant.

The long-term case for Cisco

Cisco Logo

The bottom line is that Cisco remains a very strong company. It has the size to outcompete or absorb any real upstart competition. It can invest in next-generation technologies at scale. 

Cisco has a strong, consistent operating margin. For the next two to five years, it's fair to say that investors know what they are going to get. Using my previous calculations available above, investors can expect an earnings yield of approximately 8% annually and an annualized return on capital employed of nearly 14%. Both of these valuation metrics are far superior to Cisco's competitors and the rest of the Dow.

Of all the companies on the Dow Jones Industrial Average, Cisco today is the best value investment target. Do your homework, and let me know what you think on Facebook here.

Are you ready for this $14.4 trillion revolution?
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Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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