Do you like to gamble on penny stocks? Tickers selling for less than $5 per share can deliver absolutely massive gains if you get lucky, but these companies are rarely proven performers, and many of your penny stock bets will result in negative returns. That's fine as long as you know what you're getting yourself into and are prepared to take some dramatic losses along the way. Many of these stocks are cheap for a reason, after all.
But you don't have to steel yourself for total losses if you focus on high-quality companies with healthy business plans instead. Their shares will usually cost quite a bit more, but you won't lose any sleep over their day-to-day market performance. The real key to successful investing is to buy top-shelf companies at reasonable prices, and then sit back to watch them post massive growth for many years or even decades.
One share of network equipment veteran Cisco Systems (CSCO -0.60%) sells for roughly $40 today, and that's a steal for this fantastic company. Let me show you why you should prefer a single Cisco share over 10 shares of some shady $4 penny stock.
Why are Cisco's shares so cheap today?
Cisco's shares have fallen 16% since Aug. 12, which was the eve of the company's fourth-quarter earnings report. The stock tumbled more than 11% lower the next day alone and has stayed at these lower levels ever since. At these prices, Cisco is trading at deeply discounted valuation ratios, like 19.6 times free cash flow and 12 times forward earnings.
The price cut was based on Cisco's modest guidance targets for the first quarter. Sales are expected to fall approximately 10% compared to the year-ago period. Adjusted earnings should drop approximately 17% lower.
The company launched an updated line of network switches aimed directly at the small to medium business sector just before the COVID-19 crisis arrived. That turned out to be unfortunate timing because that particular client cohort is experiencing dramatic financial pressure from the pandemic. Even so, the Catalyst 9000 series showed double-digit percentage growth in fourth-quarter sales.
"When the customers are buying, they are buying the new portfolio hand over fist," Cisco Chief Financial Officer Kelly Kramer said on the fourth-quarter earnings call. "The legacy products falling off is really what's driving [the falling revenues], but that's why we have faith and feel good about the portfolio when we come out of this environment."
Buy Cisco now and don't worry about it for the next decade or so
In other words, Cisco's management feels confident that the company will bounce back strongly in the post-pandemic era. The company's annual budget for research and development sits at $6.4 billion today, and it's hard to find a Cisco rival whose annual R&D expenses exceed a single billion dollars. Cisco's coffers are bulging with $29 billion in cash equivalents balanced against just $12 billion in long-term debt. This communications technology giant should be able to innovate its way out of nearly any conceivable crisis, the coronavirus pandemic included.
So that's a stock you can buy with confidence while its share prices are low like they are right now. Cisco will get back on its feet and the stock price will follow suit. Plus, you'll also get to lock in an effective dividend yield of 3.6% at these prices. That's a better bet than 99% of the penny stock lottery tickets in this market, and you can quote me on that.