Cisco's Making New Highs, but the Stock's Still Cheap

I'm not holding my breath for Cisco (CSCO 0.37%) to return to its robust growth levels of the dot-com era. But with shares making new 52-week highs, it seems that the Street is at least willing to consider that this company is far from a dinosaur. But how well is Cisco's transition going? While Cisco is sometimes loathed for being "too big," management has consistently executed to  keep the company relevant in end markets such as software-defined networking, or SDN.

This is despite the numerous attacks from the likes of F5 Networks (FFIV 0.38%) and Juniper (JNPR -0.64%). And despite the recent highs, Cisco still looks undervalued. And I don't think the Street has fully priced the company on its cash-rich growth prospects. In other words, yes, it's at a 52-week high, but there's still a lack of conviction.

So far so good, but...
Granted, Cisco didn't guide expecting an all-star performance. But the company has a history of under-projecting. And it's still unclear when tech spending is going to fully recover. Plus, enterprise spending has yet to show clear signs that CIOs are ready to loosen those purse strings. To that end, the company has been moving aggressively to establish a presence in areas such as wireless and data center.

These are good businesses. And the new acquisitions such as BroadHop should help strengthen Cisco's mobile policy control initiatives. But it's unclear whether Cisco can be as ground-breaking in mobile like Aruba Networks or catch fire like Palo Alto Networks in security. That's not to suggest that Cisco's core routing and switching businesses have become chopped liver. But they are not the pillars of the company that they used to be.

In the recent quarter, switch revenue grew 3% year over year, while routing revenue shed more than 5%. This followed a soft first-quarter, when both dropped 2% sequentially and 3% year over year. For that matter, the routing business, which now comprises of 16.1% of Cisco's total revenue, shed more than 1% sequentially. This means routing is now 1% less of a focus in Cisco's business. And I think that's how management wants it.

Plus, it's clear that Cisco is transitioning from hardware. Or at the very least, the company is looking to offset that focus by deploying new resources toward software. And I think the company's making good progress. But the Street still seems unsure. This is the only way I can define why both Juniper and F5 trade at price-to-earnings ratios that are more than four times and twice the valuation of Cisco. This is despite Cisco's market lead. It's as if the Street is saying, "You're no longer a laggard, but you're in the wrong markets."

Better results will propel the shares higher
While Cisco does not post the double-digit growth of F5 or Riverbed (RVBD.DL), this company seems more serious about the bottom line and just posting consistent results. On the other hand, neither company can match Cisco's cash flow and returns on capital. And I think Cisco understands this, even though that seems to escape investors.

Cisco is working toward the future and is no longer playing tit-for-tat with rivals and chasing growth at all costs. But this does not mean that the company is content with 5% growth. While Juniper and Riverbed have looked for ways to cut costs, Cisco has been spending. And a key acquisition of Intucell, a specialist in carrier network automation, just may have signaled where the next leg of growth is going to come from.

Besides, in the meantime Cisco's core routing and switching businesses are still going to produce tons of cash. The company still owns more than 50% share of that market. And it's not as if Juniper is in a position to steal market share. And Riverbed has been making new lows each week since reporting a weak fourth quarter. And although F5 has made significant progress lately and has attracted a lot of attention, I think Cisco is one key acquisition away from unleashing serious punishment in the security business. And a deal for Palo Alto networks should get the job done.

What of the stock?
That's the key question here for investors. I typically get nervous whenever a stock reaches a new 52-week high, but Cisco is in a different category. The company's maturity and solid fundamentals should prevent volatility swings. And there's still plenty to be excited about. This is even though the forward P/E does not reflect much optimism. I don't think the Street has priced in the potential synergistic advantages from recent acquisitions. Plus, just on modest free-cash-flow growth assumptions of 3%, these shares are worth at least $25.