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Saturday, March 26, 2011

What Ails Cisco?

One of the most amazing things about the rally since July is how some of the companies that formed the technology sector's old vanguard have not participated at all. Microsoft (MSFT), Intel (INTC), and Cisco (CSCO) have all been tremendous dogs, trailing the S&P 500 and their fellow tech brethren by wide margins over that period. In particular, Cisco has been atrocious.

I need do little more than put this chart before you all:

Cisco is normally a company one would associate with participating in a broad-based recovery in IT expenditures, but it hasn't. Earnings are up, yes, but investors are less than impressed. Every single earnings report in the last year has led to a significant sell-off in the stock. Click on the image above to see the little green arrows indicating earnings releases. A couple of interesting trends you will notice are the following:

1. All releases are preceded by rallies in anticipation of the results.
2. Each pre-release peak is lower than the one before it (more or less)

I think that what we are generally seeing is a reflection of analysts doing a good job of hyping the stock, long  a darling of the community, without really doing their homework. Cisco is an "overweight" by analyst consensus, meaning that they expect it to outperform the market. They have kept this rating for... well, as long as I can remember. I think that the stock is, only partially, the victim of a lousy expectations management game. In addition, their enterprise business is being badly damaged by cutbacks in public IT expenditures as part of ongoing budget stress. Their home networking business should be doing reasonably well, but unlike a pure play like Netgear (NTGR), the business has relatively little impact on their earnings.

That being said, Cisco is beginning to look awfully cheap at very low double-digit PE multiples, a discount to the overall market. Even a bad stock begins to look good when it drops enough. Still, one has to wonder if the ongoing multiple compression here represents something more ominous for Cisco.

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