My, how times have changed. It wasn't long ago that Cisco Systems (Nasdaq: CSCO) was one of the hottest stocks on the planet. CEO John Chambers was hailed as visionary, and there was no stopping this stock on its meteoric rise to its all-time high of $79.48 in March 2000. For a moment, Cisco's market cap was over $540 billion dollars.
What's more, Cisco was not alone in this temporary insanity – companies such as Intel (Nasdaq: INTC), Microsoft (Nasdaq: MSFT), and Dell (Nasdaq: DELL) also reached astronomical valuations. We all know how this ended: these stocks came crashing down and have yet to recover.
In fact, these four darlings of the past are actually now being picked up by a different set of investors -- the value hounds. While these value-seekers see Cisco as a bargain stock, the company has also picked up a large contingent of detractors, many of them former shareholders upset at a decade of lost returns.
Misguided hatred
One of the first reasons given for Cisco's unsuitability for investors' portfolios is that the stock price has gone nowhere over the last decade. Because of this, the stock must be a bad investment today. Before we draw such a conclusion, let's have a look at Cisco's results over the last decade:
|
|
Fiscal Year 2000 |
Fiscal Year 2010 |
Change |
|---|---|---|---|
| Net Income | $2,668 | $7,767 | 191.1% |
| Sales | $18,928 | $40,040 | 111.5% |
| Market Cap | $443,381 | $131,756 | (70.3%) |
| Price-to-Earnings Ratio | 166.2 | 17.0 | (89.8%) |
| Price-to-Sales Ratio | 23.4 | 3.3 | (85.9%) |
Source: Capital IQ, a division of Standard & Poor's. All dollar amounts in millions.
The first thing that stands out is how fantastically overvalued Cisco was in 2000. Cisco ended the 2000 fiscal year trading at mind-boggling multiples of 166 times earnings and 23 times sales. Such stratospheric valuations are rarely justified for any company, let alone a company that had already achieved almost $19 billion in annual sales.
Fast-forward to 2010 and we see a different picture. Not surprisingly, the company's market cap dropped like a rock. However, there's a bigger story here: a glance at the numbers actually shows that the company performed quite well. From 2000 to 2010, Cisco more than doubled sales and almost tripled its net income. Many haters would be surprised to see that the company's numbers were actually quite strong.
It's clear that those who bad-mouth Cisco based on stock performance alone are not presenting the full picture. The company has continued to improve virtually every financial metric over the last 10 years. But investors' expectations were so impossibly high that the stock was doomed to failure.
All told, it took 10 years of the stock's price dropping while its earnings improved for the stock to finally trade at a reasonable valuation. In fact, the stock currently trades at 9.8 times forward earnings, making this perhaps Cisco's first sighting in value territory.
Valid concerns
Let's now examine some actual threats for Cisco. During the last earnings conference call, management admitted that it has two problems to address: the switching market and the public sector business.
First, the switching business was down 9% year-over-year in the latest quarter. Cisco faces strong competition from Hewlett-Packard (NYSE: HPQ) and Juniper Networks (NYSE: JNPR) in this space. In order to combat this problem, the company has introduced a new portfolio of products in the switching space.
Second, public sector orders declined 8% year-over-year in the last quarter. That's not good news considering this segment makes up 20% of Cisco's product mix. With the debt ceiling a prominent headline item these days, it's safe to say that Cisco will not be seeing a significant rebound anytime soon in this area.
Additionally, there are also concerns about John Chambers and whether he is the right man to lead the company going forward. After all, despite the company's increased earnings over the years, one has to wonder whether the company could have done a better job fending off its competition.
Unfortunately for Cisco, one thing seems certain: the days of sky-high margins and ever-increasing market share may be over. With increased pressure from other companies in this space, it will likely have to give up one of the two as it likely cannot win both battles at the same time. The detractors say that Cisco will win neither battle -- only time will tell.
Foolish bottom line
The next time an investor points to a stagnating stock price as a reason for avoiding a stock, don't be swayed. One should examine a company's earnings power and its growth over time before making any claims of a company's unsuitability for investment. A falling stock price may signal falling earnings, or in this case, a fantastically overvalued past stock price that has been reverting back to a more realistic level.
If Cisco can continue to increase its numbers as it has in the past, the stock price should reverse its decline and move meaningfully higher. But whether that happens is anyone's guess.
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