While the novel coronavirus pandemic has upended several sectors, some industries are doing better than others. One such sector is tech. SPDR S&P Software & Services ETF (NYSEARCA:XSW) is up by 41.74% compared to the S&P 500, which is up by just 22.73%. One of the major contributors to this enormous success is Cisco (NASDAQ:CSCO) stock.
Many will remember the company from the dot-com bubble burst in the late 1990s. Cisco stock reached some astronomical numbers during that time. And although it hasn’t scaled those heights since, it is one of the most consistent stocks around, up approximately 33% over the last five years.
And why not? Cisco has an excellent balance sheet with very little debt. It also boasts excellent operating metrics, juicy dividend yield and is trading at a steep discount to the sector. With so much going for it, it’s hard to argue against Cisco stock right now.
Cisco Stock Is a Bargain
Although Cisco stock has recovered a bit from the drubbing it received at the height of the pandemic in March, shares are still trading at a 25.79% discount to the 52-week high of $50.28 per share. You can chalk that up to the global economic slowdown brought about by the pandemic. However, not all is doom and gloom. Several companies are in the race to manufacture a commercial Covid-19 vaccine. So, the slowdown should start letting up soon, and hopefully, pent up demand will make up for any lost sales.
Cisco is often regarded as an industry bellwether. So, if the company is facing issues, you can bet your bottom dollar that the rest of the sector is also not doing well. And let’s face it. Small and medium-term businesses are suffering, and they serve as the primary customer base for the company. Still, I believe the markets are being exceptionally unkind to Cisco stock. Yes, there will be lower demand for Cisco’s networking and communication products, but even the estimates indicate that the sluggishness will last for a couple of years. And despite the pandemic, even then, revenues are expected to be around $48 billion to approximately $49 billion during this time before the resumption of growth.
Lock on the Future
If the pandemic has done one thing, it has exponentially increased the importance of essential IT infrastructure. People are understanding that they need fast, reliable networks to manage their workload. You could argue that Covid-19 is actually a boon for Cisco.
Hence, I wouldn’t be too perturbed by the 9% year on year revenue decline during Q4’20. Overall, cash flows and revenues are moving north, while total operating expenses are going down. Another heartening sign is the share count. Cisco was one of the dot com bubble’s original darlings and inked several all-stock deals during its initial heyday. As a result, outstanding share capital ballooned.
Hence, shareholders will be happier that the company has used excess cash to fund buybacks. Cisco has spent a massive $42 billion to repurchase shares between 2017 and 2019, leading to a 12% reduction in outstanding shares.
Heart in the Right Place
Effective management is key to the long term success of any company. It may seem like tech giants like Cisco can go ahead and print money. But success is not a guarantee. And even the best companies can fumble without a reliable, stable guiding light. That’s where Cisco is lucky to have Chuck Robbins as its CEO.
After assuming his duties, in 2015, he initiated a strategy focused on shifting the company’s business mix to increase recurring revenues by using software and services. They now represent 50% of Cisco’s revenue, with subscriptions representing 80% of aggregate software revenue.
Additionally, Cisco is implementing a $1 billion cost-cutting plan to streamline operations during the pandemic. In announcing these initiatives, the company said it was looking to exit from unprofitable areas and focus its attention on transitioning most of Cisco’s portfolio to high growth areas like cloud security, cloud collaboration, and analytics.
Conclusion
Cisco’s share price does not reflect the underlying fundamentals of the company. Markets are reacting to the lowered guidance Cisco is putting out. And yes, the company is grappling with short term headwinds that will have a bearing on the bottom line for a few quarters. But the long-term growth story is intact.
That’s why I believe Cisco stock is fairly valued at the moment. Shares are trading at 15.57 times forward price-to-earnings, while the sector is trading at 32.87 times. As of this writing, the company offers a juicy dividend yield of 3.66%, and it has grown at 13% per annum over the last five years. Overall, analysts seem to agree that this guidance shortfall is a minor issue. The 12-month consensus estimate stands at $47.20 per share, a 20.8% upside to current prices.
Long story short, not only is Cisco stock trading at a steep discount to the median, but it also offers a lot of upside by all reports. It’s gotten burned a bit due to its lowered guidance, but that provides you with several more incentives to pick this one up.
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Article partially appeared on investorplace.com
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