Streetwise

Lauren Rudd

Sunday, January 16, 2011

Does Cisco Have What It Takes?

We are once again entering another earnings season and as a result you will be inundated with an onslaught of carefully worded hyperbole designed to distract your attention from any unpleasantness. As you listen to the various forecasts, keep in mind that rose colored glasses, combined with a dollop of wishful thinking, can create just as deadly a forecast as that provided by the prognosticators of doom. So do you ignore the various protestations? Absolutely not, just keep them in proper perspective.

Regardless of how the current earnings season shakes out, understand that Wall Street is often ornery and cantankerous. Yet, if you look at a graph of the major stock indexes over the past 40 years, you will see an undeniable trend upward. However, indexes fluctuate over time and those fluctuations have in the past, and will again at some future point in time, become dramatic again.

However, an index’s performance is not at all indicative of all its constituents. In fact, just the opposite is true. Many of the companies comprising an index turn in a performance that is contrary to that of the index as a whole. This dichotomy can result from a weighting factor, superior management or even a factor as simple as pure luck.

Meanwhile, as you dig out from the earnings season’s avalanche of data, remember that the Street’s analysts have a herd mentality and that their opinions and advice may not coincide with your investment philosophy and objectives. Furthermore, it is impossible to determine with any accuracy a company’s future from its past share price history. There is absolutely no “relationship.”

Does that mean you ignore the historical financial data prognostications regarding the future? Absolutely not; you simply need put the data and rhetoric in proper perspective. In other words, your goal to gain confidence...confidence in a company and its management going forward.

Worldwide IT spending is forecast to total $3.6 trillion in 2011, a 5.1 percent increase from 2010, according to the latest outlook by Gartner, Inc. In 2010, worldwide IT spending totaled $3.4 trillion, up 5.4 percent from 2009 levels.

Gartner has raised its outlook for 2011 global IT spending from its previous forecast of 3.5 percent growth. In 2010, the IT industry performed better than Gartner's previous forecast of 3.2 percent growth. Gartner analysts said currency exchange rate fluctuations have continued to affect the U.S. dollar-denominated forecast. Of the 2.2 percentage point increase in IT spending growth in 2010, 1.6 percent is attributable to the recent devaluation of the U.S. dollar against other currencies.

"Aided by favorable U.S. dollar exchange rates, global IT spending growth is expected to exceed 5 percent in 2010, but a similar level of growth in 2011 - while forecast - is far from certain, given continued macroeconomic uncertainty," said Richard Gordon, research vice president at Gartner.

"While the global economic situation is improving, the recovery is slow and hampered by a sluggish growth outlook in the important mature economies of the U.S. and Western Europe. 

One company that has been creating confidence, and an incredible accumulation of cash, year after year is Cisco. When I last wrote about the company a year ago, my earnings projection for the company’s 2009 fiscal year was $1.39 per share with a 12-month projected share price of $18, for a potential capital gain of 14.6 percent over its 2009 closing price of 15.79.

For 2009 fiscal year ended July 25, Cisco earned $1.35 per share after eliminating one-time expenses, such as those resulting from acquisitions. Given the environment for computer hardware sales in 2009, Cisco turned in an excellent performance. Furthermore, this fact was not lost on the company’s shareholders who have bid the share price up to where it recently closed at 24.64, resulting in a one-year gain of 56 percent.

Cash flow from operations for fiscal 2009 was $9.9 billion, compared with $12.1 billion for fiscal 2008. Cash and cash equivalents were $35.0 billion at the close of fiscal 2009, compared with $26.2 billion at the end of fiscal 2008, and $33.6 billion at the end of the third quarter.

For its first 2010 fiscal quarter ended Oct. 24, Cisco earned $1.8 billion, a 19 percent decline from earnings of $2.2 billion during the same period a year earlier. Earnings per share fell to 30 cents in the quarter, down from 37 cents a year ago. Sales also declined, coming in at $9 billion, down from $10.3 billion the previous year.

Nonetheless, the intrinsic value of the shares using a discounted earnings model is $29.98, while the more conservative free cash flow to the firm model produces an intrinsic value of $31.66. My 2010 earnings estimate is $1.48 per share with a 12-month price target on the shares of $27.50, for a potential capital gain of 13.6 percent.