I have not been a Cisco bull in the past because I thought the valuation was too high but I agree with this article.
Cisco Systems - Despite the Drop, This Is No Time to Give Up
By Marc H. Gerstein
Market Guide, Director of Investment Research
The unthinkable has occurred. CISCO SYSTEMS (CSCO), perhaps the single most beloved
company in the new economy, or any economy for that matter, bit the bullet and announced
EPS a penny below analyst expectations. And revenues were nearly 5% lower than the
consensus estimate. The stock had been sliding for nearly a year, but to a large extent, that
reflected the broad deflation in new-economy stock valuations. Throughout the downtrend,
CISCO's PEG (price-to-earnings-to-growth) ratio remained very high.
I'm not sure why anyone considered CISCO's disappointment news. We've heard over and over
again how spending in telecommunications was dropping. However great CISCO may be, there
was no way it could have kept chugging ahead when those around it, including its customers,
were experiencing softness. And CEO John Chambers did try to communicate a sense of reality
before the numbers came out.
In any case, the bad news is here. As this is written, CISCO shares dipped into the $20s. The
shares closed at $28.50 on Feb. 13. And the number of Strong Buy ratings on the stock fell to
10, down from 19 four weeks ago, and 22 eight weeks ago.
Regular readers of this column know I am willing to credit and use composite analyst ratings.
But I do have trouble with this profile. I never recommended CISCO before because of valuation
considerations. But not everyone invests the same way, and I can easily envision someone,
speaking eight weeks ago, being bullish on CISCO's long-term prospects. But I can't see what
changed since then to justify a rating cut. We all knew back then that telecom was hurting. We
still know, even now, that this is just a cycle, and that long-term demand for this dominant
company's products remains tremendous. And CISCO is describing the current sluggishness as
a two-quarter event, assuming the Federal Reserve remains accommodative in its interest-rate
policies. We also know that CISCO is one of the new economy's most powerful companies
when we consider its ability to survive. (The stock currently appears in Market Guide's Internet
Liquidity screen.)
If somebody liked CISCO two months ago, why turn bearish now? I suppose one could say
CISCO should be avoided until signs of renewed growth become visible. But what would make
such an analyst think he or she could spot the turn quickly enough to get on board before the
stock moves? Remember that these remarks are addressed to analysts who failed to react to
the slowdown in time to get their clients out of the stock before it fell so far.
So my point is that if you liked CISCO before and have been holding it, now does not seem an
appropriate time to sell. What about those who haven't been in the stock? As noted, I've avoided
it based on valuation. Do we now have a reasonable entry point? After re-crunching the numbers
for the new share price and the new estimates, we see a PEG ratio of almost 1.80 when the P/E
multiple is based on the July 2001 annual estimate, and 1.45 when we use the July 2002
estimate.
That's still well above the traditional 1.00 threshold. But it's not so high as to make me want to
casually dismiss the stock. After all, we're dealing with estimates, not certainties. And the
consensus EPS estimates reflect some very sharp cuts ($0.64 from $0.78 for fiscal 2001, and
$0.80 from $0.99 for fiscal 2002). Traditional stock valuation accounts for the fact that P/Es have
to be viewed differently (and higher numbers tolerated) when the EPS figure is impacted by
cyclical softness.
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