Summarized qualitatively, the case for Cisco stock (CSCO) is this: Cisco makes the guts of information technology infrastructure, routers, switches and other products associated with IT networks. Their closest competitor, Juniper Networks (JNPR), is comparatively tiny, with a market capitalization a bit over 1/9th that of Cisco’s ($13.6 billion to $125.9 billion). The ratio for the same comparison on 2009 revenue is just over 1/11th ($36.117 billion to $3.316 billion for 2009). 1 Cisco has a dominant position in the business of providing a product that supports private and public sector infrastructure worldwide to both developed and emerging nations.
Here is a comparison that illustrates the value of Cisco’s business: Apple (AAPL) – which arguably makes better personal computing products (Mac/iPad vs. PC), better smart phones (iPhone vs. other smart phones), and better music products (iPod/iTunes vs. conventional MP3s) than its competitors – may have what large groups of people want. But Cisco has what large groups of people need. If all of Apple’s products disappeared spontaneously from the face of the Earth tomorrow, there would be a lot of disgruntled people lining up to buy competing products to make do. If Cisco’s products spontaneously evaporated, cities, countries, and companies all over the world would suddenly slip into IT darkness.
Still, Cisco’s stock has not been a star since the tech bubble burst in 2000-2001. In the low $20’s ($22.05 at market close on August 17), Cisco is basically priced in the middle of its trading range for the last nine years even though its 2009 earnings per share (EPS) for the year of the financial crisis were 4.2 times its 2002 EPS.
Given the above, the investment case for Cisco is in my view intertwined with four particular reasons for downward pressure on the stock. These are:
1) No M&A premium. Lots of stocks benefit from an ongoing sugar high of takeover rumors that keep the price up. Cisco isn’t one of them. Given the dominant position and ultra large cap value of the company, including almost $40 billion in liquid reserves,2 it’s hard to imagine a scenario where anyone could buy Cisco out.
2) No dividends. Cisco is the only Dow component that does not pay dividends. 3 Consequently, many portfolios will not hold Cisco no matter how good the investment thesis, reducing demand for the stock. This is especially true at a time of post-financial crisis uncertainty, when investors are biased towards the perceived security of holdings that pay cash dividends in real time, and also make up for lost interest income due to near-zero interest rates.
3) Residual fear over tech bubble losses. On March 27, 2000, Cisco’s stock hit an all time high of $82 a share, and the firm was billed as climbing to a $1 trillion market capitalization. 4 By October 8, 2002, after losing a substantial portion of its customer base when the dot-com bubble burst, it fell as low as $8.12.5 This history provides a psychological barrier to big jumps in the stock price.
4) General post-financial crisis fears about the economy and markets.
The first point is not likely to change anytime soon, though it’s a good point for understanding why Cisco stock may not make big moves when others do. The second, third and fourth, however, may change over the next few years.
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- Cisco’s fiscal year ends on July 31, while Juniper’s ends on Dec. 31, though the comparison roughly holds for previous years. [↩]
- See Cisco’s form 8-K filed August 11, 2010, available at http://investor.cisco.com/sec.cfm?NavSection=SEC. [↩]
- See Wall Street Journal Data Center at http://online.wsj.com/mdc/public/page/2_3024-dowyield.html. [↩]
- “Firm’s market cap climbing to $1 trillion,” March 17, 2000, San Jose Business Journal, available at http://sanjose.bizjournals.com/sanjose/stories/2000/03/20/story2.html. [↩]
- See Financial Accounting Case Study: Cisco Systems, Universitat Pompeu Fabra (UPF) MBA program, December 11, 2003, available at http://www.econ.upf.edu/docs/case_studies/42.pdf, for a good summary and discussion of Cisco’s history through the tech bubble. [↩]