Cisco Systems what makes it so special-From Online Investor.
Stock of the Day
Feb 03, 1999
Cisco Systems: What Makes It So Special?
On Tuesday after the market close, Cisco Systems (Nasdaq:CSCO - news) reported earnings per share of $0.36, a penny ahead of the analyst consensus. Net income rose 33% from a year ago to $606 million and revenues rose 40% to $2.83 billion. The stock was down slightly in after hours trading, but keep in mind Cisco has more than doubled since October, from $41 to the current level near $110.
While it's not unusual for a high-flying tech stock like Cisco to trade down after beating the consensus by only a penny, the dip may also reflect concerns about competition from Lucent (NYSE:LU - news) , which just bought Ascend Communications (Nasdaq:ASND - news) . In a conference call following the report, Cisco acknowledged that the Lucent-Ascend combination presents a challenge since there is considerable overlap in markets where Cisco and Lucent will now compete.
Competition is an issue worth worrying about if it effects pricing, but Cisco has proven its ability to achieve and sustain dominance in one market segment after another, so few on Wall Street would bet against them now. Furthermore, Cisco is off to a strong start in the much-heralded convergence of voice and data networks. Telecom carrier sales "rose at least 50 percent in all geographies from a year ago and now stand at nearly 30 percent of Cisco's total revenue," according to a Reuters interview. The company pointed to major contracts with MCI WorldCom (Nasdaq:WCOM - news) , Sprint (NYSE:FON - news) and Japan Telecom in the latest quarter as evidence of its continued leadership, even as the networking market evolves from separate to converged voice-data systems using Internet Protocol for high-speed communications.
Cisco is among the top-performing stocks this decade. What makes this company so special? As much as we hear and read about Cisco Systems, it isn't like a McDonald's (NYSE:MCD - news) or a Microsoft (Nasdaq:MSFT - news) whose products are readily visible to the average Joe. Few of us have ever seen an actual switch or a router. Yet the relatively nebulous nature of its products has not held back Cisco Systems either as a company or a stock, indeed it's a bonafide Hall-of-Famer.
Cisco is the heavyweight champion of computer networking equipment, and computer networking is a huge and fast-growing industry. Just a decade ago computers sat in isolation for the most part, crunching their numbers or playing solitaire (no pun intended). Over the next ten years the urge to connect and share information blossomed, and now practically every computer connects to others in some way, whether through the Internet, on AOL (NYSE:AOL - news) or over a corporate network. That fueled a boom in demand for products like Cisco's, that is equipment which connects computers to a network and transfers the data from one PC across a network to another PC (or mainframe, or server).
As new networks are built, as more computers connect to existing networks, and as more data is sent back and forth across all these networks, the need for faster and more efficient networking equipment drives ever-increasing demand for new gear from Cisco and its industry. And now people want to send not only text and static images across these networks, but streaming video and voice telephony. So it's not as if once everything is networked, there's nothing left to sell. Corporations are continually expanding and upgrading their networks, Internet Service Providers (ISPs) must upgrade their system speed and capacity, and America Online is continually upgrading its system to handle the growing demands of its members.
That insatiable demand is reflected in Cisco Systems' corporate performance, which is nothing short of spectacular. In 1987, Cisco had sales of $1.5 million. The next year sales quadrupled to $6 million. This year the company is looking at over $11 billion in revenues -- that's nearly a two-thousand-fold increase. That is the kind of growth you see with a red-hot leader of a red-hot industry. That's what makes Cisco so special.
Cisco has simply outdistanced the competition in delivering the cutting-edge technology and end-to-end networking solutions that customers demanded. It's such a rapidly changing field that Cisco can't rest on its laurels and get comfortable, and so far Cisco has made all the right moves to establish and sustain its industry dominance.
As with so many other high-tech areas, the explosive growth of computer networking spawned thousands of companies, resulting in a highly competitive environment. Now the industry is in a phase of massive consolidation (mergers and acquisitions). An important distinction about the competition in computer networking is that, unlike other industries such as memory chips, price competition hasn't approached the point where profit margins are sacrificed like lambs to the god of market share.
Cisco sustained gross profit margins of 65.2% in the latest quarter (for a hardware maker, obscene profit margins is more like it), defying expectations that those fat margins would erode as the market matured. Net profit margins are holding around 21.5%, compared to about 3% for automaker GM (NYSE:GM - news) . Cisco's impressive and sustained profitability is just one more reason Wall Street loves this company.
Once a company reaches gigantic proportions it gets hard to sustain rapid growth, but Cisco's deceleration has been fairly modest. It remains nimble and customer-driven despite their mammoth size. Cisco expects future growth to be fueled by the "consumer phase" of the Internet revolution, predicting 30% to 50% growth in the data networking markets of countries with strong economies. Cisco aims to match or beat the industry growth rate.
With Japan still weak and South American countries like Brazil in crisis, the overall industry growth rate probably won't approach 50%. Nonetheless, analysts are forecasting Cisco to deliver annualized earnings growth of 30% over the next five years, extraordinary for a company of this size.
That phenomenal performance and consistent ability to live up to lofty expectations is reason enough for analysts to love Cisco. The outperformance of its stock is another. It's up more than 400% in the last 3 years, and something like 28,000% since it came public in the late-eighties.
With Cisco's stock price rising so dramatically over the years, it certainly merits investigation as to whether it is overvalued. At 90.9 times trailing twelve month earnings, it probably isn't attracting much fresh buying from value investors. The kind of investors who still consider buying Cisco at these levels focus more on its position as a market and industry leader, on the seemingly-unlimited potential of the Internet and Cisco's crucial role in it, and on the momentum in the stock price and earnings. Such highly regarded stocks usually don't come cheap, and now we know why Cisco is considered so special.
fnews.yahoo.com
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