5 Reasons Cisco is My Top Tech Pick for 2013
Editor's note: This article was originally published on Dec. 12, 2012.
In the past four to five years, investors have been more squarely focused on the consumer end of the tech landscape, bidding up shares of Apple (Nasdaq: AAPL), Google (Nasdaq: GOOG), Amazon.com (Nasdaq: AMZN) and others. But on the business end of high-tech, the big winners haven't been such industry leaders. Instead, most gains have come from small, but growing software and data-storage providers. But this theme may be upended in 2013, as one of the most dominant companies in the enterprise space regains its mojo.
I'm talking about Cisco Systems (Nasdaq: CSCO), which has had little to show investors during the past five years.
Blocking and tackling
Although the stock chart may give the impression of a company slowly losing relevance, nothing could be further from the truth. Cisco's operational performance has been quite solid in recent years, especially when compared to stumbling giants such as Hewlett-Packard (NYSE: HPQ), Dell (Nasdaq: DELL), Computer Sciences (NYSE: CSC), and especially when compared to more direct networking competitors such as Juniper Networks (Nasdaq: JNPR). Consider that Cisco has generated a whopping $46 billion in cumulative free cash flow during the past five years.
But Cisco can be taken to task for being a little too content to simply squeeze out cash from a largely mature business. Indeed, shares fell out of bed in the summer of 2011 simply because investors could no longer see a long-term path to growth. A number of the company's recent acquisitions had failed to deliver promised growth, and Cisco's end markets -- most notably in government and telecom -- weren't looking all that perky.
Yet in recent quarters, management has begun to talk about a sharper game plan that will likely help solidify Cisco's role in so many markets. The plan involves a number of small steps that are unlikely to lead to explosive sales growth, but should fuel a steady expansion in profit margins and a more linear trend of profit growth.
Here are the five small steps that should add up to solid gains for Cisco's shareholders in 2013.
|2. A rising focus on software|
|The company has set an ambitious target of doubling the revenue it derives from software in the next five years. This, in turn, should lead to a rising take rate for its expanding suite of service offerings. This is a page right out of the IBM (NYSE: IBM) playbook. Cisco's CEO John Chambers is surely aware of IBM's 100% stock price gain during the past five years, as investors have come to embrace Big Blue's linear growth.
You can't blame Chambers for a bit of IBM envy. IBM carries similar margins today, but its enterprise value-to-sales (EV/Sales) ratio is 40% higher than Cisco's. That's why emulating IBM is a wise move.
Furthering the IBM analogy, Chambers understands that IBM's focus on long-term service contracts leads to much smoother revenue and profit streams. The company aims to boost service revenue from a current 21% of the sales mix to more than 25% within three years.
|Chambers now spends a considerable amount of time on the road in Latin America and Asia. He's directed his sales force to treat these markets as a top priority. The timing is good as many of these markets are now increasingly home to large domestically-grown companies, and not simply the foreign divisions of firms like Wal-Mart (NYSE: WMT) and Coca-Cola (NYSE: KO). Emerging markets currently represent about $9 billion in annual sales (20% of the entire sales base), though Cisco aims to boost that figure by 10% annually in the next three to five years. To get there, Cisco is developing lower-cost solutions for these price-sensitive markets.|
Risks to Consider: To augment growth, Cisco has signaled plans to pursue a fairly hefty acquisition in coming quarters, and such deals can sometimes spook investors.
Action to Take --> Even with all of these growth-inducing steps, Cisco is only likely to boost sales in the mid-to-upper single digits each year, while per-share profit growth is unlikely to exceed 10%. But by delivering these kinds of gains in a steady linear fashion, investors are likely to reward this stock with an ever-higher multiple. When you include Cisco's massive $33 billion net cash pile, this becomes a low-multiple stock with a fairly low level of embedded expectations. This means 2013 should represent a fresh perspective for this one-time highflyer as growth kicks in.
P.S. -- Stocks like Cisco are part of a group of companies sitting on a $1.7 trillion "Dividend Vault." Simply put, the "Dividend Vault" is the easiest way we know to collect thousands of dollars in dividends each month for the rest of your life. To learn more, click here.
StreetAuthority LLC owns shares of CSCO in one or more of its “real money” portfolios.