Should You Sell Cisco Stock After Its Second-Quarter Earnings?

Cisco's (CSCO 0.06%) stock recently tumbled after the networking giant posted its second-quarter numbers. Its revenue fell 4% annually to $12 billion, beating estimates by $30 million. Its non-GAAP net income stayed flat at $3.3 billion, but buybacks lifted its EPS 5% to $0.77 and topped expectations by a penny.

Cisco cleared Wall Street's low bar, but it still grew at its slowest rate in over two years. Should investors stick with the sluggish tech giant and wait for a cyclical rebound? Or should they sell Cisco and move on to more promising tech stocks instead?

Image source: Getty Images.

Cisco's slowdown continues...

Cisco's revenue and earnings growth in the second quarter was dismal compared to growth in previous quarters:

YOY = Year-over-year. *Non-GAAP. Source: Cisco quarterly reports.

Cisco's total products revenue, which accounted for 72% of its top line, fell 6% annually during the second quarter as its infrastructure and applications revenues both slid 8%.

It attributed its weak infrastructure growth to soft demand for switches from campus and data center customers, and sluggish sales of routers to service providers. As far as applications, poor sales of its Unified Communications products offset the double-digit growth of AppDynamics, which it acquired nearly three years ago.

The only bright spot was its security revenue, which grew 9% on robust demand for its identity and access, advanced threat, and unified threat management products. That business was also boosted by its acquisitions of Duo and Umbrella (formerly known as OpenDNS).

Cisco's services revenue, which accounted for the remaining 28% of its top line, rose 5% annually with strong demand for its software and solutions support services -- but that growth couldn't offset its fading product revenue.

Image source: Getty Images.

For the third quarter, Cisco expects its revenue to dip 1.5%-3.5% annually and for its non-GAAP earnings to rise 1%-4%. Both estimates matched analysts' conservative expectations but indicated that its slowdown would continue through the end of the year.

...but its margins are still expanding

Cisco's revenue growth is decelerating, but its gross and operating margins expanded sequentially and annually during the second quarter:

Non-GAAP basis. Source: Cisco quarterly reports.

That stability reflects Cisco's scale and the growth of its higher-margin software and security businesses. The company also benefited from cyclically low DRAM prices, which partly offset its lower pricing power in hardware and the weakness of the server market.

By comparison, its smaller rival Juniper Networks (JNPR -1.45%) posted a non-GAAP gross margin of 59.5% and an operating margin of 20.3% last quarter.

For the third quarter, Cisco expects to generate a gross margin of 64.5%-65.5% and an operating margin of 32.5%-33.5% -- which would represent a quarter-over-quarter contraction, but also an expansion from a year earlier.

Big buybacks and a dividend hike

Cisco's business hasn't hit a cyclical trough yet, but it's trying to appease investors with big buybacks and dividends.

It returned $2.4 billion to shareholders during the quarter, including $0.9 billion in buybacks and $1.5 billion in dividends, and reduced its outstanding shares by about 5%. It also raised its quarterly dividend by a penny to $0.36 per share, which boosts its forward yield to about 3%.

Juniper pays a slightly higher forward yield of 3.3%, but it arguably faces tougher headwinds than Cisco as a distant underdog in the saturated networking market.

Should you sell Cisco or wait for a rebound?

Analysts expect Cisco's growth to rebound in fiscal 2021 with 3% revenue growth and 5% earnings growth. Based on those estimates, Cisco's stock looks cheap at 15 times forward earnings.

But as Cisco also warned in its conference call, its own guidance doesn't reflect "any potential disruptions in our global supply chain that could result from the coronavirus." So if the novel coronavirus outbreak hitting much of Asia right now worsens, Cisco could struggle to meet Wall Street's expectations, and its cyclical downturn could last longer than expected.

That being said, I don't think there's a compelling reason to sell Cisco right now. Plenty of bad news is already baked into its stock price, it still has plenty of cash for fresh acquisitions, and its low valuation and high yield should set a floor under the stock. Cisco definitely won't rally anytime soon, but it remains a solid stock for long-term investors.