Back in November, I wrote that I expected Cisco Systems (CSCO) to continue its comeback. At that time, shares had recovered from their 52-week low of $13.30 to stand at $17.75. The company had spent much of the previous year regrouping, cutting costs, and refocusing on its core businesses, and I expected first quarter numbers to show an improvement in the bottom line. From there, I reasoned that the outlook for sales was positive and margins should grow. At $17.75, the shares were a buy. Now at $20.25, and three months and two announcements of results later, it's time to take another look.
In November, Cisco shares were trading at a price to earnings ratio of 15.23. First quarter earnings per share surprised on the upside, as I suspected they would, by 4 cents ($0.43 versus expectations of $0.39). Similarly, its second quarter numbers surprised by the same amount when they were reported on February 8. Coming in at $0.47 as against expectations of $0.43, they again showed an out performance of 10%. This continuing pattern of better than expected earnings has led to every analyst raising full year forecasts over the last couple of weeks. Earnings for the full year are now expected to come in at $1.83 per share. This puts the shares on an implied price to earnings ratio of 11.06 for this year, and with earnings next year expected at $1.98 a forward price to earnings ratio of 10.25. This forward price to earnings ratio is a little higher than back in November, when the comparative number was 9.47. At the current market price of $20.25, shares are trading on a trailing price to earnings ratio of 15.75.
Margins have improved, too, though I suspect the margin improvement will become more obvious going forward.
Operating margin back in November was 20.25%. Now this number is at 21.61%. Profit margin has increased from 15.02% to over 15.5%. Return on equity at Cisco is a healthy 14.74%.
During the period, Cisco's cash pile has grown. From $44.59 billion, it now stands at $46.74 billion. With debt standing still, this has led to a slight fall in its debt/ equity ratio to 34.3: very manageable with its operating cash flow and cash generative business.
Having introduced a dividend, at the current rate of $0.08 per share the implied dividend yield is 1.6%, and with cover of over 5 times there's plenty of room to do more on this front should Cisco wish to do so.
The one potential cloud on the horizon is the enormous cash pile. What should Cisco do with it? Cisco certainly has the flexibility to make income generative acquisitions, pay a special dividend to shareholders, or repurchase shares. Maybe a combination of all three. Any or all of these would be good news for shareholders.
With shares trading above the rising gradient of the 50-day and 100-day exponential moving averages with the 50-day above the 100-day, the 12-month chart shows a good rising trend. I would expect this to continue in the coming months.
If results continue to outperform expectations by 10%, then this would imply a full-year earnings per share number of around $1.93. If the trailing price to earnings ratio remains constant, as it has since November, then I would expect the share price to be in the region of $29 to $30, with even better to come next year. It is my belief that the market has not yet caught on to Cisco, even with the more than 50% bounce from last year's lows.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
