Cisco (NASDAQ: CSCO) is usually considered a slow-growth stock, but shares of the networking equipment giant surged nearly 40% over the past 12 months. That rally might seem baffling, since Cisco reported negative sales growth and anemic earnings growth over the past few quarters.
Nonetheless, Wall Street remains bullish on Cisco, with 16 analysts rating it as a "buy", three considering it "overweight", nine ranking it as a "hold", and none calling it a "sell".
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So looking forward into 2018, should investors buy Cisco, or should they wait for a pullback? To decide, let's examine four reasons to buy Cisco and four reasons to avoid it.
4 reasons to buy Cisco
- Cisco remains the 800-pound gorilla in networking hardware. During the third quarter of 2017, it controlled 56.7% of the ethernet switching market and 41.4% of the enterprise and service provider router market according to IDC.
- Cisco pays a forward dividend yield of 2.9%, which is much higher than the S&P 500's current yield of 1.8%. That dividend, which has been hiked annually since its inception in 2011, is supported by a low payout ratio of 59%.
- Cisco's Applications and Security businesses respectively posted 6% and 8% annual sales growth last quarter. Those businesses only accounted for 15% of Cisco's revenue, but they're gradually offsetting the slower growth of its Infrastructure (switching and routing) businesses.
- Cisco finished last quarter with $71.6 million in cash, cash equivalents, and investments, but just $2.5 billion of that total was available in the US. This makes Cisco a major beneficiary of the Trump Administration's decision to reduce the 35% corporate tax rate in the US to 21%, and taxes on repatriated income from 35% to 8%-15.5%. If Cisco repatriates most of its overseas cash, it could significantly boost its buybacks or dividends, or pursue domestic acquisitions (especially in the higher-growth security, wireless, and collaboration markets) without issuing more debt. All those moves could boost shareholder value and transform Cisco's core business.
4 reasons to avoid Cisco
- Cisco still dominates the switching and router markets, but IDC's aforementioned market share figures represent year-over-year declines from the third quarter of 2016 when Cisco controlled 57% of the ethernet switch market and 44% of the enterprise and service provider router market. Cisco's top rival Huawei gained ground in both markets during that period. Arista Networks (NYSE: ANET), which specializes in switches for software-defined networking (SDN) solutions, also grew its market share. Arista is especially dangerous, since its switches and open-source Linux-based OS are optimized for generic "white box" network setups. These cheaper setups undermine Cisco's traditional strategy of selling its networking hardware and software in bundles.
- Despite the improvements in its Applications business, Cisco's Infrastructure business continues to post negative sales growth. As a result, analysts expect its total revenue and earnings to respectively rise just 1% and 3% this year.
- Those anemic growth rates aren't fully justified by Cisco's valuation. Cisco currently trades at 21 times earnings, which is lower than the industry average P/E of 35 for communication equipment vendors but marks its highest trailing multiple since 2010.
- Cisco's high P/E ratio indicates that the stock is being propped up by two main things -- its decent dividend and rosy expectations for its repatriated cash. However, rising interest rates could cause investors to dump higher valued dividend stocks like Cisco, and there's no guarantee that Cisco will repatriate all of its cash from low tax havens like Ireland.
The verdict: Avoid Cisco (for now)
Cisco had a good run, but I think there's too much optimism baked into the stock. Its routers and switches are still losing ground to aggressive rivals like Huawei and Arista, and the growth of its Applications business is barely offsetting those declines.
Cisco is a low-risk stock, but I don't think it's a great buy with the stock's P/E hovering at multi-year highs. If you're interested in buying Cisco, wait for the stock to drop on rising interest rates or doubts about its repatriation plans before starting a position.
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Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Arista Networks. The Motley Fool recommends Cisco Systems. The Motley Fool has a disclosure policy.