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Should Investors Worry About Cisco Stock?

By Timothy Green – Aug 22, 2020 at 8:20AM

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The pandemic is hitting the networking hardware company hard.

Shares of Cisco Systems (CSCO -1.41%), the leading provider of enterprise hardware and a major player in the cybersecurity and collaboration markets, were hammered earlier this month. Cisco's fiscal fourth-quarter report, while beating analyst expectations across the board, featured a steep revenue decline and an outlook that called for more pain ahead.

Revenue tumbled 9% for Cisco in the fourth quarter, driven primarily by a 16% decline in the core infrastructure platforms segment. Cisco's customer base is composed of large enterprises and organizations that tend to pull back on spending when the economic outlook becomes cloudy.

With the COVID-19 pandemic far from over, the economic outlook is about as uncertain as it gets. Cisco anticipates a 9% to 11% plunge in revenue in the fiscal first quarter -- guidance that the market did not like. Cisco stock is now down roughly 12% since the start of the year.

Data cables plugged into server equipment.

Image source: Getty Images.

Downturns are nothing new

While this steep and persistent revenue decline is certainly not good news for Cisco investors, any longtime Cisco stockholder knows that demand downturns occur regularly. Cisco is the market leader in the enterprise switching and routing markets. In the first quarter, the company claimed a 57% share of the Ethernet switch market, a 65% share of the enterprise router market, and a 35% share of the service provider router market, according to Synergy Research Group.

This dominant market position means that Cisco's sales are mostly going to grow and shrink in sync with the overall market for these products. Smaller players can grow by winning market share, while Cisco has a limited ability to do that.

Because demand for enterprise networking hardware goes through cycles, so does Cisco's revenue. The current downturn is the sixth time Cisco's year-over-year quarterly revenue growth has dipped into negative territory in the past 20 years.

CSCO Revenue (Quarterly YoY Growth) Chart

CSCO Revenue (Quarterly YOY Growth) data by YCharts

The sales slump Cisco went through during the financial crisis was worse than the current one (at least so far). That downturn was followed by a sharp rise in sales as Cisco's customers played catch-up. The current downturn will likely give way to a strong recovery as well, although the timing is anyone's guess.

In the long run, will demand for enterprise networking gear be hurt by the pandemic? It seems unlikely. If anything, demand could grow at a quicker pace in the future, driven by increased working and learning from home. The pandemic has not changed Cisco's long-term story.

A decent value in an expensive market

Cisco produced adjusted earnings per share of $3.21 in fiscal 2020. Based on that number, the stock now trades for just 13 times earnings. For comparison, the S&P 500 sports a PE ratio of 29.

Cisco's earnings will likely decline this year, so the stock may not be quite as cheap as it looks. And being primarily a hardware company, Cisco certainly doesn't deserve as high a valuation as a dominant software company. But with many tech stocks hitting all-time highs and trading at nosebleed valuations, Cisco is one of the few bargains left in the tech sector.

It will take time for Cisco's sales to recover, and the pace of that recovery will be dictated by the trajectory of the pandemic and the length and severity of the recession. This could be a long downturn for Cisco, so investors should brace themselves for rough results in the coming quarters. But in the long run, Cisco's dominance should remain intact.

Timothy Green owns shares of Cisco Systems. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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