After spending more than a decade in tech purgatory, languishing well beneath its high-water mark achieved during the peak of the 2000 tech bubble, networking provider Cisco Systems, Inc. (CSCO 1.16%) has enjoyed an unexpected resurgence. Year to date, its stock price has nearly tripled the S&P 500 index's returns, advancing almost 23% since the beginning of the year. Over the past 12 months, the stock price has risen almost 50%. For a mature tech company like Cisco, this is indeed some heady growth! Have investors missed the boat? Is the stock too expensive to initiate a position now?
As crazy as it may seem, Cisco's renaissance is just beginning, with more market-beating returns to come in the years ahead. Let's take a closer look at why this might be the case.
In Cisco's fourth quarter, the company showed growth in its four largest product categories. Image source: Getty Images.
Solid growth and guidance
When the company reported its 2018 fourth-quarter earnings last month, revenue rose to $12.8 billion, its highest quarterly revenue ever, and good for a 6% increase year over year. Its adjusted earnings per share (EPS) grew to $0.70, a 15% increase year over year. This growth was led by gains across its four largest product categories.
| Cisco Product Category | 2018 Q4 Sales | Change YOY (Loss) |
|---|---|---|
| Infrastructure platforms | $7.44 billion | 7% |
| Services | $3.20 billion | 3% |
| Applications | $1.34 billion | 10% |
| Security | $0.63 billion | 12% |
| Other products | $0.23 billion | (18%) |
| Total | $12.84 billion | 6% |
Data source: Cisco Systems, Inc. YOY = year over year.
On top of its quarterly gains, the company also guided for more growth to come. The company expects revenue to grow 5% to 7% over 2017's Q1 and adjusted EPS to come in between $0.70 and $0.72, an almost 16% gain over last year's first quarter.
A shifting business model
Selling hardware, such as switches and routers that Cisco sells, can be a tough business. During economic downturns, customers often put off orders for long periods of time, and when times are good, competitors can swoop in and drive down prices. This can make sales lumpy, frustrate shareholders, and depress the stock's valuation. It also gives the business less vision as to what the future holds.
For these reasons, Cisco has been shifting to a recurring revenue model, where customers subscribe to Cisco's products and services and pay on a monthly basis. This quarter, recurring revenue made up 32% of Cisco's total revenue, and software subscriptions made up 56% of Cisco's total software revenue. Cisco's deferred product revenue from recurring software and subscriptions rose to $6.1 billion, a 23% increase year over year.
Cisco's Catalyst 9000 switches represent the company's first attempt to sell a subscription software package on top of a core networking product. How has that gone? In the company's fourth-quarter conference call, CEO Chuck Robbins said the switch series "has been the fastest ramping product that we've ever built." When asked if future switching and router products would be sold with the same recurring revenue model, he replied:
I'm very pleased with how the adoption has been from our customers. They understand the value. As I said early on, we knew when we started that process that we would need to deliver significant innovation that wasn't available in the traditional methodology of buying it in order for our customers to adopt it and some of those were the encrypted traffic analytics, the overarching automation capability, and then recently some assurance. You'll see us over the next coming quarters when we bring new products to market ... across the portfolio, we will apply that same strategy.
Cash is king
Perhaps Cisco's biggest advantage comes from its mountain of cash. Earlier this year, Cisco repatriated about $67 billion from overseas money after new tax legislation was passed. After spending billions on share repurchases ($6 billion last quarter alone), dividends ($1.5 billion last quarter), and acquisitions, the company is still sitting on $46.5 billion in cash and cash equivalents. That's a lot of dough!
While the acquisitions will continue, especially when Cisco has an opportunity to bring an an innovative product or service under its corporate umbrella, shareholders should directly receive much of this money. Cisco still has $19 billion authorized for making stock repurchases with no expiration date. Earlier this year, Cisco raised its dividend by 14%, making it the seventh consecutive year the company has given shareholders a double-digit percentage raise, and with its large stockpile of cash, I believe it is unlikely that streak will end next year.
Final thoughts
Despite the run-up in price over the last year, based on its $2.60 in non-GAAP EPS for the full 2018 fiscal year, Cisco's shares sell at what seems like a reasonable P/E ratio of 18.2. Given the company's growth across its different product divisions, its shift to a recurring revenue business model, and its fortress-like balance sheet, I don't believe it's too late for investors to enjoy market-beating returns from here.
