A famous technology stock with a settled future

Business is on an improving trend at this household name and orders are growing at their fastest in a decade. Our overseas investing expert also likes the undemanding valuation.

Rodney Hobson is an experienced financial writer and commentator who has held senior editorial positions on publications and websites in the UK and Asia, including Business News Editor on The Times and Editor of Shares magazine. He speaks at investment shows, including the London Investor Show, and on cruise ships. His investment books include Shares Made Simple, the best-selling beginner's guide to the stock market. He is qualified as a representative under the Financial Services Act.

In no other sector is being nimble on your feet more important than in the ever-changing world of computer technology. So it is good to see Cisco Systems Inc (NASDAQ:CSCO) looking to the future with plans to diversify from its traditional networking products.

This is a complicated business, but in a good way as it is well placed to profit from whatever areas of technology are in demand at any given time. It is the world’s largest hardware and software supplier within the networking sector, with products used in routing, data centres, wireless communications and the Internet of Things. Its security operations provide firewalls while services include advanced technical support.

Cisco, based in San Jose, California, is among the many companies suffering from the continuing shortage of memory chips and power supply units. This worldwide problem will not go away soon – certainly not in 2021 at least – and it will put pressure on profit margins in the company’s hardware products, although this part of the business will continue to grow.

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Source: interactive investor. Past performance is not a guide to future performance

However, Cisco now expects half its profits to come from software and recurring revenues, which augurs well for the foreseeable future.

The latest results, for the financial year to 31 July, were reasonable, though admittedly unspectacular. They showed revenue edging 1% higher, from $49.3 billion to $49.8 billion, while net income slipped 6% from $11.2 billion to $10.6 billion and earnings per share from $2.64 to $2.50.

However, the damage was done during the first half of Cisco’s financial year when the pandemic disrupted corporate clients and data centre customers’ purchases of networking hardware, a situation exacerbated by the loss of contracts in China as trade wars escalated.

There has been an improving trend since. The May-July quarter this time brought an 8% increase in revenue, the top end of previous guidance, to $13.1 billion, while net income jumped 14% to $3 billion and earnings per share to 71 cents. The growth in orders was the best for a decade.

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With working from home still helping to inflate revenue and profits, Cisco expects revenue to grow 5-7% in its current financial year to next July, while earnings per share will be at least $2.72 and possibly as high as $2.84. 

Comparisons are going to get tougher as the effects of the pandemic unwind, so that kind of growth, assuming it happens, will be quite impressive. The prospects of balanced growth and increases in subscription income, which gives greater visibility of earnings, suggests that good times will indeed continue to roll.

Cisco shares were bumping along around $30 five years ago before starting to swing wildly, hitting $58 in summer 2019 then plunging back to $35 twice last year. They recently hit a new peak of $59 before coming off the boil again to around $56. 

There is, though, no fear that they will plunge violently again. In fact, several brokers including Goldman Sachs, Credit Suisse and JP Morgan have been raising their price targets to between $64 and $74.

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The yield is 2.6%, which is better than for many US tech stocks, and it looks secure given Cisco’s long payment history and its promise to return at least half of free cash flow to shareholders. 

While that also includes share buybacks – the company bought back 1.2% of its stock market capitalisation over the past year, making an aggregate reduction of 16% over five years – there should be scope to increase the dividend, though probably not at the 20% compound rate of the past 10 years. The shares trade at 15 times future earnings, which looks undemanding.

Hobson’s choice: Buy up to $60. The swings should be less severe given Cisco’s settled future.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.