CSCO is down almost 10% since May - should you buy the dip?

August 2, 2018

CSCO is down almost 10% since May – should you buy the dip?

Cisco Systems Inc. (CSCO) is one of the most recognizable and established companies in the Technology sector. With a market cap of nearly $200 billion, they are also one of the largest, if not THE largest player in the Networking & Communications segment. They are, without question, the standard that all other networking businesses are measured and compete against. 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 the next generation of technology in the so-called “Internet of Things” (IoT).

It’s ironic, perhaps that despite CSCO’s unquestioned dominance in its market, the stock has mostly languished for nearly two decades. After riding the “dot-com boom” of the late 1990’s to a peak at around $80 per share, the stock cratered when that boom went bust, dropping to as low as about $8 in late 2002. From that point it never rose higher than into the low $30 range – at least not until the latter part of 2017, when the stock finally broke that top-end resistance. That pushed the stock to a high in May a little above $46 per share as Tech stocks generally prospered.



Recently, however, it seems that CSCO has fallen victim to the latest “Amazon rumor mill” phenomenon that has afflicted companies like CVS Health Corp (CVS), The Kroger Company (KR), and others who watched their stock price slide amid rumors Amazon.com (AMZN) was looking for a way to expand its business into their respective industry. The latest rumor is that AMZN is considering branching their Web Services unit into network switching hardware – the same technology that CSCO has dominated for more than two decades. 

Despite the fact AMZN has provided no validation of the rumor, and in fact has given to indication they were in fact considering the move, or actually developing any such products, the mere suggestion has been sufficient to help drive the stock from that May high price to its current level a little below $42 per share. That might not sounds like much of a drop, but it does represent a 10% decline in the stock price – enough that some analysts have been recommending investors should “buy the dip.”

I’m not sure that I agree. While I recognize CSCO’s dominance in its industry, expect it to continue, and recognize the company’s core fundamental strength, my reliance on value analysis also forces me to look at the stock’s current price in more conservative terms. It looks very overvalued right now. The company is due for its latest earnings report later this month, and that report could alter my perspective somewhat; but as of now I have to believe the stock is at a greater risk of a steeper decline than it is of staging a rebound to test its recent highs. Here’s what I mean.



Fundamental and Value Profile

Cisco Systems, Inc. (CSCO) designs and sells a range of products, provides services and delivers integrated solutions to develop and connect networks around the world. The Company operates through three geographic segments: Americas; Europe, the Middle East and Africa (EMEA), and Asia Pacific, Japan and China (APJC). The Company groups its products and technologies into various categories, such as Switching; Next-Generation Network (NGN) Routing; Collaboration; Data Center; Wireless; Service Provider Video; Security, and Other Products. In addition to its product offerings, the Company provides a range of service offerings, including technical support services and advanced services. The Company delivers its technology and services to its customers as solutions for their priorities, including cloud, video, mobility, security, collaboration and analytics. The Company serves customers, including businesses of all sizes, public institutions, governments and service providers. CSCO has a market cap of $197 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings grew by a little over 11%, while sales growth was more modest, at about 4%. Growing earnings faster than sales is hard to do, and generally not sustainable in the long-term; however it is also a positive mark of management’s ability to maximize their business operations. In the most recent quarter, both metrics grew about 4%. Over the last twelve months, the company also reported negative Net Income of about $1.2 billion, raising questions about their operating costs and margins.
  • Free Cash Flow: CSCO’s free cash flow over the last twelve months is more than $12 billion. This is a number that the company has historically managed to maintain at very healthy levels. It should be noted that the negative Net Income just mentioned appears to be a temporary phenomenon, and the company’s massive “war chest” of cash really makes it just a temporary blip on the radar.
  • Debt to Equity: CSCO has a conservative, manageable debt-to-equity ratio of .44. I already alluded to the company’s large cash position; at more than $54.4 billion, it is also more than twice the total amount of long-term debt shown on their balance sheet. The company also recently announced the repatriation of approximately $67 billion of cash from overseas resulting from the passage of tax reform, with plans to use the money to fund a 14% dividend hike and a $25 billion increase its ongoing share repurchase program as a clear effort to return value to their shareholders.
  • Dividend: CSCO currently pays an annual dividend of $1.32 per share, which translates to an annual yield of 3.15% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for CSCO is $9.69 per share, and this is where the biggest cracks in the bargain argument really exist. At the stock’s current price, its Price/Book ratio, at is more than 4.34, is nearly twice as high as its historical average of 2.42; a drop to par with that average puts the stock at risk of a decline of more than 43% (around $23.50 per share) from its current price. That would also put the stock at price levels it hasn’t seen since early 2016.



Technical Profile

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

 

  • Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s upward trend until early May and provides the reference for calculating the Fibonacci retracement levels indicated by the horizontal red lines on the right side of the chart. The stock’s decline from that point has followed a pretty gradual slope, which to some is a positive indication. I tend to believe the opposite is true, since gradually sloping trends, in any direction are generally easier to sustain over an extended period of time. It can also be argued that the more gradual a trend’s slope is, the more likely the trend’s momentum becomes to accelerate in the direction of that trend; at some point, more and more investors will take note of the trend and be likely to overreact to it. The stock is currently quite near to the 38.2% Fib retracement level around $40.25, with $38 or even $36 (the 50% and 61.8% Fib levels, respectively) not far out of reach. Compared to the upside if the stock reverses the short-term downtrend, you have about $5 per share in either direction, which translates to a 1:1 risk-to-reward ratio right now.
  • Near-term Keys: “Buying the dip” right now is pretty risky move, and when the potential opportunity is identical to the likely risk, it’s hard to say that’s a good decision to make. The risk: reward profile could change if the stock comes a little closer to the 38.2% retracement line, and then pivots back to the upside; that could offer a reasonable opportunity to go long in the stock or to start working with call options, with a tight stop set just below that retracement line at around $39 per share. A drop below $40, on the other hand might offer a reasonable opportunity to short the stock or start working with put options, with a closing target price in that case in the $36 range.


By Thomas Moore Investiv Daily Technology Value Traps Share: