Safe Technology Mega Cap Stock For The Patient Value Investor

“Safe” and “Technology” Stock do not go together. Again “Value” and “Technology” do not go together though this category is showing a growing number of companies. Cisco (CSCO) like Intel (INTC) and Microsoft (MSFT) belongs to the older technology generation compared to new kids on the block like Zynga (ZNGA), Facebook (FB) and LinkedIn (LNKD). Like older technology companies, Cisco also trades at a lower valuation multiple due to the lower expected growth rate. However unlike the other technology value plays, Cisco does not suffer from the same competition intensity. The company is also expanding rapidly into newer technology areas like mobile computing, cloud computing, video conferencing, web-based collaboration, data center servers. and network storage. Cisco’s large size implies that it will not show dramatic growth, but it will not show a big decline either (HP, Dell).

Why We Like Cisco

Offers Good Value

Cisco has traded in a range of $14 to $28 over the last five years and is currently lying in the middle of that range at ~$20. The company is trading near its 52 week high of $21 which is somewhat in line with the general stock market. Cisco trades at a forward P/E of ~10x with a solid dividend yield of 2.8%. The company has produced an average FCF of $9 billion in the last five years giving it a FCF yield of 12x. The company has a massive war chest of $29 billion in cash which implies that the ~27% of the company’s stock price or $6 is accounted by cash alone. If you leave out the cash, then the P/E is only ~7.5x.

The company has managed to keep on growing slowly and steadily without making any big waves. Cisco has shown an 8.5% growth in revenues and a 12.5% growth in earnings over the last 3 years. The book value and OCF have also grown at the same steady rate. Cisco did not give a dividend till 2010, but now has started giving a handsome yield along with its massive billion dollar buybacks. The management has committed to use 60% of its FCF for buybacks and dividends.

Intel like dominance in Networking

Cisco is like the Intel of networking, with only one competitor that is much smaller in size. Juniper Networks (JNPR) has been competing with Cisco for a long time now but has never really been a serious threat to Cisco. While Cisco has not managed to decimate Juniper like Intel vanquished AMD, Juniper isn’t going to challenge Cisco dominance anytime soon.

$10 billion of FCF per year used to gobble up any potential competition

Cisco has built its reputation as the premier global supplier of enterprise-class networking equipment and software over a long period. The company keeps buying networking startups and companies to keep up with technology innovation. The company has used ~$68 billion in the past to buy a large number of companies. M&A integration is a separate function in Cisco, given the large number of acquisitions it makes.

Getting out of the Consumer Technology Space

Some companies are just not good with consumers and are best in B2B segment. Cisco is one such company that has repeatedly failed to achieve success in consumer technology markets. It bought the maker of the Flip camcorders, but failed to leverage this buy and had to ultimately shut down it down. Same thing with the Wi-Fi router maker Linksys. The company bought one of the leaders in the segment but is now trying to sell it as well. The company has belatedly realized its weakness and is remedying it. We consider this to be a good sign.

Growth in New Segments and Customer Diversification

One of strengths of Cisco is its ability to grow in newer product areas. The company in its most recent quarters showed strong growth in the Data Center (61% growth), Wireless (38% growth) and SP video revenue (30% growth). None of its competitors have such a strong and a wide product range. The company is also not dependent too much on one type of customer such as Telecom providers or Enterprises or Government.

Read about List of Cloud Computing Companies in India.

Summary

Cisco like other mega cap technology stocks such as Corning (GLW) will never be multi baggers. That is the curse of being a mega cap as the law of large numbers catches up with you. However, Cisco like Corning has a huge competitive moat and generates billions of dollars in FCF each year. These companies have started giving a decent dividend besides buybacks, making them ideal for patient value investors.

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