Please ensure Javascript is enabled for purposes of website accessibility

Is Cisco Systems, Inc. a Buy?

By Matthew Cochrane – Apr 13, 2018 at 8:07PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

For years, the company's primary business of selling switches and routers has stalled. Is Cisco finally turning the ship around?

The stock price of Cisco Systems, Inc. (CSCO -0.15%) has recently enjoyed a bit of a renaissance. The company, which develops and sells networking hardware, has seen its shares increase almost 100% over the past five years compared to the S&P 500 index's 67% return. This, even though the business has not shown any fundamental improvements in its numbers over the same period. Don't believe me? Consider: In its 2013 fiscal year, Cisco reported $48.6 billion in revenue and $10 billion of net income. In its 2017 fiscal year, the company reported...wait for it...$48 billion in revenue and $9.6 billion in net income. That's right, over four whole years, the company's revenue and net income actually inched down, not up!

So, if the company isn't recording more sales and earning more income, why are analysts upgrading the stock even after huge moves to the upside? When one looks under the hood, beyond the headline numbers, there are reasons to believe the company is past the better part of a major transition, one that could see it return to growth for years to come. Let's take a look at what some of these catalysts are and whether they make Cisco's stock a buy for investors today.

Rows of switches and routers basked in blue light.

For years, Cisco's top and bottom line growth has inched downward. Are things finally beginning to change? Image source: Getty Images.

A return to innovation

Can an old dog learn new tricks? Cisco's meat and potatoes has always been designing and selling network hardware like switches and routers. While the company has made extremely successful forays into other markets, like cybersecurity, the vast majority of its sales still come from selling hardware.

When the company reported its 2018 second-quarter results, its infrastructure platforms accounted for $6.7 billion, a 2% increase year over year. This accounted for 56% of its total revenue for the quarter and helped Cisco grow its revenue by 3% year over year, its first revenue increase in two years. In fact, a lot of its numbers showed positive movement in the second quarter.

Cisco Systems Metrics 2018 Q2 2017 Q2 Change
Revenue $11.9 billion $11.6 billion 2.7%
Recurring revenue $3.93 billion $3.6 billion 9.3%
Non-GAAP EPS $0.63 $0.57 10.5%

Data source: Cisco Systems, Inc.

What drove this increase in sales? The company seems to have finally figured out that it needs to continue innovating its router and switching products, or else smaller competitors, such as Arista Networks Inc (ANET 1.67%), will eat its lunch and steal market share. On this front, Cisco looks like it is delivering. In the company's second-quarter conference call, CEO Chuck Robbins talked about the successful launch of the company's new switching platform, the Catalyst 9000:

We saw strong adoption of our subscription-based Catalyst 9000 switching platform as we more than doubled our customer base from last quarter to over 3,100 customers. This is the fastest-ramping new product introductions we've had in our history and a fantastic example of the innovation we've delivered over the past two years. When I became CEO, I challenged our team to increase the pace of innovation in the space, and I could not be more proud of what they've accomplished.

Later in the call, CFO Kelly Kramer shared an anecdote from a former customer who regretted switching to a competitor after learning of Cisco's new data center capabilities which "allows them to manage not just your switches but ... newer versions of the enterprise routing and wireless."

A recurring dream

Selling hardware in today's tech world is a tough business. Cisco (along with other hardware vendors) is often at the mercy of big orders from large enterprises. If these customers suffer a downturn in business, they can often put off buying new equipment for a year or longer. Smaller competition can come in and try to undercut legacy companies on price, or out-innovate them on niche products. This makes revenue growth for hardware developers especially fragile. This is one reason Cisco is desperate to transition to a more software-centric, recurring revenue business model, and thus far, results are encouraging.

In Cisco's second quarter, 33% of total revenue was recurring, including 52% of software revenue and 13% of hardware revenue. Robbins said the plan for new switches, like the Catalyst 9000, is to sell subscription bundles of security and analytics features. Kramer disclosed how happy the company was with the demand.

Cash is king

For years, one of the biggest questions surrounding Cisco has been when it would finally get a chance to repatriate the cash it held overseas. The new tax legislation accomplishes just that, allowing the company to bring in an estimated $67 billion; even for multinational tech conglomerates, that's a lot of money. After paying taxes, Kramer said this money would be dedicated to three areas: acquisitions, buybacks, and dividends.

Kramer said acquisitions "are a critical part of our -- and always have been -- of our overall strategy." In Q2, the company raised its quarterly dividend to $0.33, a 14% increase. This gives the company's shares a dividend yield of about 3.2% which, given the recent surge in price, is remarkably high. The company also announced it would dedicate an additional $25 billion to the share repurchase authorization plan, meaning that over the next 18 to 24 months, Cisco would have a total of $31 billion to deploy for buybacks.

Final thoughts

Despite the company's slow business model transition and stagnant growth, there appear to be green shoots in Cisco's long-fallowed ground. Given the stock's surge in price over the past year, is this growth already baked into the stock's share price? I don't think so. Based on its adjusted EPS over the trailing 12 months of $2.45, the company still trades for a relatively attractive price-to-earnings ratio of 16.6. Given the company's hoard of cash, growing dividend, and huge repurchase program, I could see why income and value investors might be tempted. While I am not pulling the trigger on buying any shares yet, it's a company that will be on my short watchlist going forward.

Matthew Cochrane owns shares of Arista Networks. The Motley Fool owns shares of and recommends Arista Networks. The Motley Fool recommends Cisco Systems. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Cisco Systems, Inc. Stock Quote
Cisco Systems, Inc.
CSCO
$40.52 (-0.15%) $0.06
Arista Networks, Inc. Stock Quote
Arista Networks, Inc.
ANET
$110.92 (1.67%) $1.82

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
327%
 
S&P 500 Returns
105%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/27/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.