Is Cisco Ready for a Breakout Year?

Cisco Systems (NASDAQ:CSCO) has been a solid Blue-Chip performer recently, gaining around 25 percent since the beginning of the year. A longtime market leader in routing and switching hardware, Cisco has recently expanded into the fast-growing field of software-defined networking. With a new focus on SDN, is Cisco positioned for new heights in 2013? Let’s use our CHEAT SHEET investing framework to determine whether Cisco is an OUTPERFORM, WAIT AND SEE, or STAY AWAY.

C = Catalysts for the Stock’s Movement

CEO John Chambers recently declared that Cisco is now an “IT company.” Shareholders should be excited about this change because most of the company’s growth in third quarter came from non-traditional business lines: its data center, wireless, and service provider video units. Cisco is well positioned to capitalize on the rapidly growing SDN industry with its secretive Insieme spin-off. It is important that they achieve first-mover advantage in the SDN market as rival, Juniper (NYSE:JNPR), is also gunning for market share.

Cisco recently acquired data analytics firm Composite Software for $180 million in a bid to sell more subscription-based software. The transition from hardware, namely routers and switches, to software should actually help Cisco’s already high margins of 61 percent. Routers and switches, however, still make up two-thirds of the company’s revenue. Cisco has experienced strong hardware sales in the past two years as companies have increased their IT spending budgets to pre-financial crisis levels.

E = Earnings are Increasing Year Over Year

Cisco reported strong third quarter earnings figures on May 16, beating analysts’ estimates. Pleasant surprises are nothing new for Cisco shareholders come earnings time—the company has experienced six straight quarters of positive growth in earnings per share. Most recently, Cisco benefitted from strong sales in its service provider video, data center, and wireless divisions.

Q3 2013 Q2 2013 Q1 2013 Q4 2012 Q3 2012
Qtrly. EPS Growth YoY 15.00% 47.50% 18.18% 59.05% 21.21%

*Data sourced from YCharts

E = Excellent Relative Performance to Peers

Cisco stacks up well against its major competitors: Alcatel-Lucent (NYSE:ALU), Hewlett-Packard (NYSE:HPQ), and Juniper. The company enjoys the second-highest gross margins in the category at 61 percent. Because of Cisco’s mighty economies of scale and high switching costs in the routing and switching business, these margins are relatively safe from competitors—smaller upstarts don’t really stand a chance. Cisco announced it would pay a dividend in 2011. The dividend yield has grown steadily since then, and, at only a 29 percent payout ratio, the company has room to increase its dividends in the future. While its five-year growth prospects are not as impressive as Juniper’s, Cisco is trading at a lower forward price to earnings multiple, implying that it is relatively cheaper.

CSCO ALU HPQ JNPR
Forward P/E 11.73 N/A 6.77 14.88
Growth (5 yr.) 8.33% -26.40% 0.00% 15.04%
Gross Margin 0.61 0.30 .24 .64
Dividend Yield 2.80% N/A 2.40% N/A

*Data sourced from Yahoo! Finance 

T = Technicals are Bullish

At $24.63, Cisco is currently trading above both its 50-day moving average of $23.56 and its 200-day moving average of $21.53, indicating the company is experiencing an uptrend. The stock has plateaued at around $24 after a positive third quarter earnings announcement on May 16. Cisco is trading close to its 52-week high of $24.98.

Conclusion

Cisco will continue to enjoy its high market share in the routing and switching business because of high switching costs to consumers. Additionally, the company is well positioned to profit from the coming SDN revolution.

Cisco has acquired several data services and analytics companies, and formed new SDN divisions within the parent company as it acts on its commitment to enter the higher margin IT services and software business. Because Cisco is currently trading near its 52-week high, investors don’t really have a good entry point into the stock right now; however, due to the upside with Cisco’s new business lines and its attractive and growing dividend, Cisco is an OUTPERFORM.

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