Are CSCO’s improving fundamentals keeping up with its trend?

Cisco Systems Inc. (CSCO) is one of the most recognizable and established companies in the Technology sector. 

With a market cap of more than $200 billion, and a clear position as a leader in the Technology sector, companies like CSCO are, without question, the standard against which all other business in their respective industries are measured and forced to compete with. No matter whether you’re talking about wired or wireless networking, CSCO is one of the companies that not only developed the standards and infrastructure the entire Internet is built on today, but that continues to lead the way into the future, including cloud-based computing and the next generation of technology in the so-called “Internet of Things” (IoT).

2022 saw a lot of volatility in the marketplace, which isn’t surprising given the global issues that have dominated investor’s attention. I also don’t think it’s all that surprising that most of those issues – inflation, supply chain concerns, rising interest rates, geopolitical uncertainty – have carried through so far in 2023. Those issues put the Tech sector, including networking companies, on the bleeding of the market’s broad downturn last year, and at the forefront of the market’s rally that started in the last quarter of last year. Looking ahead, it’s reasonable to expect Technology stocks to continue to lead the market up or down as the tides of global economic activity continue to ebb and flow.

One of the most interesting stories of the past three and a half years has been the pandemic-driven trend that saw corporate America shift to remote working models. While many businesses have begun moving back to in-office operations, more seem to be adopting a hybrid workforce approach that combines in-office with remote work. That further validates the need for cloud-based solutions that facilitate effective hybrid workforce models. CSCO may not be getting a lot of the buzz about their services in this area, but the truth is that this company has been providing these exact solutions and services for more than two decades, from Wide Area Networking, to remote video and teleconferencing, and more. CSCO is also a big player in the 5G, next-generation WiFi, and IoT world, which represents the next stage in remote connectivity in ways that we are really only beginning to experience and appreciate. Analysts are predicting a practically insatiable appetite from consumers and businesses alike for next-generation bandwidth, which bodes well for CSCO’s investments in those businesses, and should act as a headwind in the months, and even years to come.

While it hasn’t attracted the same kind of attention that other media-darling tech companies have seen, CSCO’s fundamental strengths, which are considerable suggest that many of enterprise-level end markets that struggled through 2020 and 2021 are beginning to recover, even while other of its cloud-based solutions (which help enable many of the remote working models described earlier) have continued to provide healthy revenue growth. CSCO is a company with a balance sheet that features outstanding liquidity, very low debt relative to liquid assets, strengthening Free Cash Flow, and a healthy operating profile. 

At the start of 2022, broad market uncertainty hit the Tech sector hard, pushing CSCO off of that $64 high and down to a 52-week low in early October at around $38.50. The stock rallied strongly off of that low, pushing to a high in April of this year at around $52.50. The stock dropped into the start of May to a new, major pivot low at around $45.50, but has been surging again from that point to its current price at around $50. Do the company’s fundamentals, along with the latest price activity suggest it might not be too late to jump on the bandwagon, or has the best probability of long-term, value-based opportunity already passed by? Let’s find out.

Fundamental and Value Profile

Cisco Systems, Inc. is engaged in designing and selling a range of technologies that power the Internet. The Company is integrating its platforms across networking, security, collaboration, applications and the cloud. The Company operates through three geographic segments: the Americas; Europe, Middle East, and Africa (EMEA), and Asia Pacific, Japan, and China (APJC). The Company’s products categories include Secure, Agile Networks; Internet for the Future; Collaboration; End-to-End Security; Optimized Application Experiences; Other Products, and Services. Secure, Agile Networks consists of its core networking technologies of switching, enterprise routing, wireless, and compute products. Internet for the Future consists of its routed optical networking, public fifth generation (5G), silicon, and optics offerings. Collaboration consists of its Collaboration Devices, Meetings, Calling and contact center offerings. End-to-End Security consists of its overall security offerings. CSCO has a market cap of about $204.7 billion.

Earnings and Sales Growth: Over the last twelve months, earnings increased by about 12.8%, while sales were 13.5% higher. In the most recent quarter, earnings increased by 15.8% while sales grew by 7.2%. CSCO has a very healthy operating profile, with Net Income running at 20.89% of Revenues over the last twelve months. In the last quarter, that number increased to 22.04%.

Free Cash Flow: CSCO’s free cash flow over the last twelve months is $16.9 billion. This is a number that the company has historically managed to maintain at very healthy levels, and increased from $12.8 billion a year ago. It also marks an increase over the last quarter from $15.5 billion. The current number translates to a Free Cash Flow Yield of 8.31%.

Debt to Equity: CSCO has a conservative, manageable debt-to-equity ratio of .16. CSCO’s balance sheet shows $23.3 billion in cash and liquid assets (up from $19.2 billion a year ago) against about $6.6 billion in long-term debt. Servicing their debt is not a concern, and liquidity to pursue additional expansion or return value to shareholders via stock buybacks or increased dividends is excellent. It is also worth noting that long-term debt decreased by about than $1.8 billion over the past year, and a little under $1 billion from the quarter prior.

Dividend: CSCO currently pays an annual dividend of $1.56 per share (increased in 2021 from $1.44 per share, $1.48 at the start of 2022, and $1.52 at the start of this year), which translates to an annual yield of about 3.12% at the stock’s current price. An increasing dividend is a strong sign of management confidence.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target at around $53 per share. That means that at its current price, CSCO is slightly under-valued, with about 5% upside at its current price. It also puts the stock’s bargain price at around $42. It should be noted that in the first quarter of 2021, this same analysis yielded a fair value target at $41.50 per share, $45 earlier this year, and $50 prior to the most recent earnings announcement.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The chart above covers the last year of price activity. The diagonal red line traces the stock’s upward trend from its low in October at around $38.50 to its April high at around $52.50. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. After dropping off of that April high to a short-term low at around $45.50 in May, the stock has rallied again and is nearing expected, immediate resistance at around $50.50, based on pivot activity seen in April as well as December of last year at that level. Current support should like at around $49, based on pivots seen in January, February and March in that area. A push above $50.50 should give the stock momentum to test its 52-week high at around $52.50, while a drop below $49 should see limited initial downside to next support at around $48. An acceleration of bearish momentum, however could see the stock test next support at the 38.2% retracement line, right around $47 per share.

Near-term Keys: Based on my traditional valuation metrics, I can’t call CSCO a value right now; but I do think there are a number of other elements – continued remote workforce services and solutions, 5G implementation over the next year or so, and continued improvement in corporate, enterprise spending on IT infrastructure, to name just a few – that aren’t being factored into my value analysis because of their forward-looking nature. If you’re looking for a way to work with a 600-lb gorilla in the Tech sector with a stable, attractive, and increasing dividend, those elements, along with the stock’s current momentum could be good enough to make this an exception to the normal value-based argument. If you prefer to work with short-term trading strategies, a push above $50.50 could provide a signal for an aggressive, bullish investor to buy the stock or work with call options, with a short-term eye on $52.50 as a practical exit target. A drop below $49 could be a signal to consider shorting the stock or to buy put options, with a useful exit target at about $47 on a bearish trade.