I’ve been on a bit of a risk-avoidance kick for a couple years. Maybe I’m just getting old. But I find it harder and harder to recommend any stock I’m not convinced is ultra-safe and dirt-cheap. So I don’t recommend as many stocks as I used to many years ago. But the ones I do recommend tend to perform well more often than not.
And I’m actually having more fun in my work now. Because when I find a stock I like, I don’t just recommend it and move on to the next idea. I stick with it and pound the table until it breaks in half for as long as the stock is cheap. Like I’m doing these days with computer-networking giant Cisco (CSCO), for example…
[ad#Google Adsense 336×280-IA]On Wednesday, Cisco announced blockbuster earnings and a dividend raise.
Shares soared more than 9% on Thursday.
Rising earnings and dividends are music to my ears.
They mean the business is becoming more valuable, and that value is making its way into shareholders’ pockets.
The market is totally wrong about Cisco.
It’s way too cheap… providing our readers with a fantastic opportunity.
I first recommended Cisco in the February 2011 issue of Extreme Value. At the time, Cisco’s stock was down 73% from its March 2000 highs (prior to the bursting of the tech bubble). Meanwhile, the company was what I called the “World Dominator of Internet plumbing.” It makes the routers and switches that allow the Internet to exist.
Cisco was trading at only 10 times free cash flow (a no-growth valuation). And the company had excellent financials. Here’s what I wrote about Cisco then…
Like all other World Dominators, Cisco is a huge free cash flow generator. Last year, Cisco generated over $9.1 billion in free cash flow. That’s 23% of sales. Imagine owning a business where $0.23 of every $1 in sales flows through in cash. That’s pretty rare, two or three times what you get from most profitable public companies.
Like our other big tech picks, Microsoft and Intel, Cisco is one of the financially strongest companies in the world. Cisco’s balance sheet is a financial fortress. Cisco has nearly $39 billion of cash and securities, and just over $15 billion of debt – more than $23.6 billion in net cash. Gross cash and securities equal about 31% of its market cap.
About half of Cisco’s total assets are in cash and liquid securities (mostly government bonds and agency mortgage-backed securities). It could easily carry much more leverage. Last year, it earned 14.7 times more in operating cash flows than it made in cash interest payments.
Cisco has done an excellent job of returning cash profits and excess capital to shareholders. In Q3 2010, it spent $2.7 billion on share repurchases, more than all but five S&P 500 companies (Hewlett-Packard, Wal-Mart, IBM, ExxonMobil, and Procter & Gamble). Since 2003, it’s spent more than $65 billion on share repurchases.
Unlike many corporations, Cisco has an excellent track record of taking cash out of the business and distributing it to the company’s owners, its shareholders.
This week, Cisco announced a quarterly sales increase of 4.4% from a year ago to $11.7 billion. The company earned $1.9 billion in the fiscal fourth quarter, up 56% from $1.2 billion a year ago.
Cisco also increased its quarterly dividend 75% from $0.08 a share to $0.14 a share. The company only started paying a dividend in April 2011. It has increased the dividend by 133% since then. I expect the company to keep raising the dividend annually for several years to come. It also bought back 108 million shares in the July quarter, for a combined $1.8 billion.
This is the hallmark of a great business for shareholders. It gushes plenty of extra cash flow, and management makes sure a large amount of that cash goes straight into shareholders’ pockets…
On the post-earnings conference call, Cisco Chief Financial Officer Frank Calderoni noted the company increased profits faster than revenue in the quarter. The company estimated non-GAAP (generally accepted accounting principles) gross margins at 61%-62%. Calderoni pledged to return a minimum of 50% of the company’s free cash flow to shareholders going forward. That’s a huge increase. In the fiscal year just ended, Cisco returned 37% of free cash flow to shareholders.
Compare that with an investment bank like Goldman Sachs that pays 50% of its total revenue as employee compensation. As the old saying goes, “Where are the customers’ yachts?”
There ought to be more companies like Cisco (and probably more Goldman Sachs executives in jail). Most corporations are lousy at investing the profits they make. Shareholders would be better off receiving the cash as a dividend… or getting a boost from a share repurchase program that only buys the stock when it’s cheap enough (like Cisco’s shares are right now).
In its just-ended fiscal year, Cisco returned $5.9 billion to shareholders in buybacks and dividends – more than 6% of the company’s market capitalization and more than 50% of free cash flow.
Although thanks to a recent selloff, Cisco is currently showing a loss in our Extreme Value portfolio… I still believe it’s one of the safest investments in the world today. It currently trades at an enterprise value (market cap + debt – cash) of seven times free cash flow. The stock could appreciate 58% from here to about $30 a share, and it’d still only be trading at an enterprise value of 13 times free cash flow. So there’s plenty of upside here. The market is crazy to value this excellent business as low as it is.
— Dan Ferris
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Source: The Growth Stock Wire