Please ensure Javascript is enabled for purposes of website accessibility

Why Cisco Is Overdue for a Reemergence

By Will Healy - Jan 28, 2020 at 9:48AM

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

Both software and 5G could help move Cisco higher.

As the overall market trades near record highs, companies like Cisco (CSCO 0.93%) seem to lag. Cisco stock has risen by just under 250% since the March 2009 lows. This does not compare well to the S&P 500, which increased by over 375% over the same period. Tech giants such as Microsoft (MSFT 0.51%) and Apple (AAPL 2.00%) have seen more dramatic growth.

These lower returns might make investors wonder why they would want to buy Cisco stock. However, with its latest 5G and software technology, Cisco could finally make a long-awaited comeback.

The rise and fall of Cisco

Cisco stock was a darling of the dot-com boom in the late 1990s. So dramatic was its surge that it briefly overtook Microsoft as the company with the world's largest market cap in March 2000.

The shadow of a human head with patches of light and data superimposed on it and a wall of data showing on the side.

IMAGE SOURCE: GETTY IMAGES

However, the stock would go on to lose more than 90% of its value by September 2002. The company survived and rebranded itself. It even joined the Dow in 2009. Today, Cisco stock appears to fit the stereotype of a Dow Jones stock. Profit growth remains mired in the single-digits. Also, the one-time tech darling that once eschewed dividends now has increased its payout every year since it was introduced in 2011. However, Cisco stock still sells for about 40% less than it did at its peak almost 20 years ago.

Will it rise again?

In a sense, Cisco has already risen again. This networking company, previously known for hardware, now derives a significant percentage of its revenue on the software and services side. Products such as Silicon One, Exablaze, and its white-box solution should help to drive revenue growth. This growth should particularly accelerate with wider 5G adoption. As more consumers and businesses utilize artificial intelligence, virtual reality, the Internet of Things, and other technologies, Cisco technology will play a significant role in supporting this connectivity.

Moreover, its financials remain strong. Since bottoming out at below $10 per share in 2002, adjusted earnings per share has risen more than sevenfold. Despite this growth, investors can now buy Cisco at a much lower cost than during the height of the dot-com bubble. The company which once supported a P/E ratio of more than 200 today trades at a more modest multiple of 19.4.

Cisco poised for long-term gains

Investors should not anticipate Cisco stock returning to a 200-plus P/E ratio. However, with the stock trading below 20 times earnings, a 5G-led revival could drive multiple expansion.

Admittedly, for that to happen, earnings will have to return to double-digit growth rates. The company has not seen those levels of increases for several years. Profits grew at an average of 7.76% per year during the previous five years. For the next five years, Wall Street predicts that that average will fall to 6.99% per year. Competition from the likes of Juniper, Arista, Huawei, and others will make larger earnings increases more difficult to attain. Unless the company can produce more substantial profit growth, sustained multiple expansion is unlikely.

Still, even if profit growth does not come as quickly as expected, investors need to take note of the dividend. At the current stock price of about $48 per share, Cisco stock yields about 2.9%. Still, given payout hikes of the last eight years, another increase will probably happen this year. Barring major disruptions, annual payout hikes will probably continue for the foreseeable future. 

Cisco's outlook continues to improve

In the latter part of 2019, Cisco suffered through a rough patch. In its August earnings report, the company announced that revenue growth would likely come in flat to up just 2% for the upcoming quarter. The stock dropped by close to 20% over the summer as concerns about slowing sales weighed on the sector.

However, conditions have turned out better than some had feared. Management predicted revenue growth accurately, reporting 2% growth at the upper end of its range in the most recent quarter. 

Also, the trade picture has improved dramatically. Since the U.S. signed the phase one trade agreement with China, both countries have a greater degree of uncertainty on trade. The Asia-Pacific, Japan, and China (APJC) region accounted for 15.2% of sales in 2019. China makes up a relatively small percentage of those sales. Still, with sales in China having fallen 31% in the previous quarter, a deal should offer welcome relief. With China trade no longer hampering growth, both revenues and Cisco stock itself can move higher.

Now is the time to buy Cisco

Both 5G and software will help propel Cisco higher. Cisco built its reputation as an internet hardware company in the 1990s. However, in today's market, hardware has become a commodity that generates little in profit. Cisco pivoted more toward software years ago, and with wider 5G adoption coming soon, it could finally share in some of the spoils enjoyed by other tech giants.

Cisco could face some difficulties. The competition will present challenges as the company struggles to return to double-digit earnings growth. However, with the move into 5G, and a rising dividend that pays investors to wait, Cisco stock could shoot higher as preparation meets opportunity.

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
$43.09 (0.93%) $0.40
Apple Inc. Stock Quote
Apple Inc.
AAPL
$145.78 (2.00%) $2.85
Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$267.56 (0.51%) $1.35

*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
322%
 
S&P 500 Returns
113%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/07/2022.

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.