At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.
But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.
Alas, poor Cisco, (we thought we) knew it well
Here we go again, Fools. Once more, Cisco Systems (Nasdaq: CSCO) has delivered to Wall Street an earnings report deemed subpar. And once again, Wall Street is throwing a hissy fit. Already, Citigroup, Stifel Nicolaus, and Piper Jaffray, have thrown in their collective towels and downgraded Cisco in response to Wednesday's earnings. Expect more downgrades to come. (Phrasing a rating just right takes time, and not all analysts can type at 60 words per minute.)
And yes, the news was bad. Once again, we're seeing Cisco cede share to Motorola (NYSE: MMI) in the cable set-top box market. Once again, the company appears to be losing ground in Internet switches, as rivals Juniper (Nasdaq: JNPR) and Hewlett-Packard (NYSE: HPQ) eat its lunch. (Albeit, Cisco seems to be beating off an attack on its routers business from Riverbed and F5 Networks (Nasdaq: FFIV); router revs, at least, were up a few percent for the quarter.)
Discussing the earnings news Thursday, The Wall Street Journal pointed out how Cisco seems out of step with fellow tech giants EMC (NYSE: EMC) and IBM (NYSE: IBM), both of which reported "record" revenues and profits last month. It paints Cisco in an especially unfavorable light relative to rival Juniper, which crushed earnings with a 26% rise in Q4 sales. No wonder, then, that Wall Street is abandoning this sinking ship.
Is Cisco sinking or seaworthy?
But ... is the ship really sinking at all? I don't mean to impugn the skills of the analysts making the downgrades this week. To the contrary, according to our data, Citi, Stifel, and Piper are all great analysts, ranking within or above the elite 10th percentile of investors we track on CAPS. But I do believe they're missing the point. Far from being a sinking ship, I see Cisco ready to set sail, and deliver greater profits to investors in the quarters and years to come.
Why? Really, it's a question of price. Earlier this week, as you may recall, I discussed a pre-earnings upgrade of Cisco made by some truly brilliant analysts at Avian Securities. At the time, I checked Avian's math and concluded that with a 10.7 enterprise value-to-free cash flow ratio, and 12% growth projections on the stock, Cisco did indeed look modestly underpriced.
Sure, some investors may criticize Avian's decision to upgrade the stock just hours before earnings as "bird-brained." But I stand by my endorsement of the call. In fact, I'm doubling down on it. Here's why:
Valuation matters
If Cisco's numbers this week had showed the company was shedding free cash flow, thus hurting the valuation on the stock, then yes, I'd be inclined to "downgrade" the stock myself. But in fact, the opposite is true. According to Cisco's cash flow statement, operating cash flow in the first half of fiscal 2011 exceeded the amount Cisco churned out in fiscal H1 2010 by $302 million. Capex rose as well -- up $244 million -- but this still leaves Cisco $58 million richer than it started out. It raises the company's rate of free cash flow generation, even as a frustrated (and misguided) Mr. Market chops the price of the company by 13%.
Foolish takeaway
Result: Post-sell-off, Cisco now sells for an enterprise-value-to-free-cash-flow ratio of not 10.7, but 10.2.
Put another way, thanks to last quarter's guidance, we already knew to expect a weak report from Cisco this week -- and that's exactly what Cisco gave us. What we did not know was that despite the tough environment, Cisco would be able to grow its free cash flow, even as investors decided to shrink its price by 13%. Yet that's just what happened.
Call me stubborn, call me a Fool -- but I'm going to have to disagree with Wall Street this week. To me, the sell-off at Cisco makes the stock look more buy-able than ever.
