- Cisco stock has fallen around 13% since August 14th.
- Stock became oversold in August when the RSI level dipped below 30.
- The fundamentals of Cisco stock are still very strong despite competition headwinds.
- Since 2011, the dividend payout has gone up from $0.06 a share to a present $0.21 a share. The company's solid financials iindicate that the dividend will keep growing.
Biotech stocks and some tech stocks have had amazing rallies over the last 7 years. Ever since the Fed started with its quantitative easing programs in 2009, most sectors rallied but some rallied more than others. Commodities for example rallied until 2011 but has been in a bear market since. Equities have done very well with the S&P 500 (INDEX:SPAL) going from 666 in March 2009 to over 2,100 before sliding a touch. However it is nothing compared to the biotech sector iShares NASDAQ Biotech Index (NASDAQ:IBB) which has rallied over 460% since hitting a bottom in March 2009. Some stocks in the tech sector such as Netflix (NASDAQ:NFLX) had had huge run-ups while Cisco (NASDAQ:CSCO) performance hasn't been bad either, but yet its share price is nowhere near the levels it attained during the tech bubble in the year 2000. Nevertheless with fears of a tech bubble on the horizon, I like the fundamentals of Cisco and one of the big reasons is its growing dividend. Therefore if you are an investor who believes that long commodities/short tech is the safe trade now but still want exposure in the tech space, then Cisco may very well be your stock.
Cisco Has Strong Fundamentals
Firstly if we are going to hold Cisco stock, let's look at the fundamentals to see if they stack up. We need to see healthy growth rates across all the important metrics over a 10 year period.
- Total Assets - $106.2 billion - 10 Year trend is up - Pass
- Net Income - $9 billion - 10 Year Trend Is Up - Pass
- Revenues - $49.2 billion - 10 Year trend is Up - Pass
- Price history of the stock - Up 40% in the last 10 years excluding dividends - Pass
- Gross Margin - 60% - Falling slightly - This metric is down on the 10 year chart but it up over a 3 year period
- Is it recession proof ? - The stock recovered quickly after the 2009 recession but it still has not surpassed its 2007 highs
- Years Of Dividend Increases - 5 years - Pass
- Competitive Advantage - Meaningful switching costs, brand equity, scale advantages - pass
The one metric that some analysts would point to as being bearish would be the company's gross margin which is presently around 60%. This number has come down from nearly 70% 10 years ago which illustrates more competition in this sector. Also, the revenue growth rate in its switching division is declining bit by bit (see chart).
Nexus 9000 Switches To Ward Off Competition
Cisco seems to be facing major competition in this area from white box manufacturers. These manufacturers are unbranded players who not only sell cheaper server systems but also give their clients the opportunity to customize the systems according to their needs. Once Cisco saw this threat, it started to build Nexus 9000 switches which is the company's fastest ever switch. Apparently the take up on these new switches and the optional SDN software is excellent among Cisco's customers and the company is confident that investors will see good growth in this division in the coming quarters.
I expect the same because the switching costs for customers (from one vendor to another) is quite high in this industry. When you combine the brand this company has built up through the years, the thousands of IT personnel who know no other system , the certification and the afore mentioned switching costs, it is hard to see Cisco having to sell its switching systems at lower prices.
Internet Of Everything
Nevertheless in investing, we always have to protect against the downside. If the likes of Facebook and the white box manufacturers do indeed get their way and Cisco's margins in its switches division plummet, what is there to protect it? Well I still believe this company will be able to keep its gross margin levels in the 60's because of its service division which is still growing substantially. Cisco's new initiative "Internet Of Everything" or "IoE" is enabling the company increase the number of installed product currently sold to companies. The service division becomes more lucrative when there is more product to service. If its "IoE" continues to gain traction, the revenue (see chart) will continue to grow which should offset any potential margin pressures in its switching division.
Strong Dividend Payout
Finally, one of the main reason why I like this Cisco stock presently is the dividend yield which is approximately 3.26%. Apart from the yield, it is the growth rate which has really gotten investors attention. Have a look at how the company has increased its dividend since 2011 in the chart below.
As the above chart shows, the company has just declared a cash dividend of $0.21 which was inline with analysts projections. Furthermore what tech investors need to remember here is that this stock has a p/e ratio of 14.63 and a forward p/e ratio of 11.53 meaning currently it is a very cheap company for an industry leader. Moreover if we get a downturn in this sector, you are getting paid to wait. With a net cash position of around $35 billion and a payout ratio of 0.46, the growth in the dividend seems ultra safe going forward. I expect the company to use its increasing cash balance to make more acquisitions ( it acquired seven companies in the last quarter), return cash to shareholders through share buybacks ($8.3 billion was returned to shareholders through buybacks in fiscal 2015) and also through increasing dividends. Furthermore the more competition that enters this sector, one would feel, the more Cisco will up its R&D budget which is an area Cisco is renowned for.
To sum up, I feel Cisco is a good risk/reward trade at the moment especially when you factor in the dividend. Its cash & cash equivalents balance continues to grow (now topping $60 billion) but the stock has still not recovered from its August decline (see chart). The RSI level reached 30 but still looks oversold in my eyes. Any price under $27 a share is a good entry here.