Stock of the Week
NASDAQ Symbol: CSCO
Price as of 5/13: $21.27
We've had a years' worth of gains in four short months thanks to a little PE expansion in the broader market. Sell in May and go away has not worked except for the utility sector. Utilities and other interest rate sensitive sectors have come under pressure as interest rates start to rise once again. Since mid-April we've seen some sector rotation with money coming out of the top defensive sectors into the underperforming Materials, Industrials, and Technology. Tech was the worst performing sector just a short few weeks ago. Better than expected earnings and a substantial share buyback and dividend hike from Apple has boosted the tech sector. Intel and Microsoft have also perked up. This week we'll highlight another blue chip tech with a great dividend. The stock of the week is Cisco Systems. Cisco will report earnings Wednesday night, so cautious investors may want to wait, but longer term money is rotating into blue chip dividend paying tech stocks. Cisco looks like it has more room to run barring any disappointing announcements following earnings.
Investors are hungry for income and the bond market no longer provides adequate income particularly when you take into account the risks of this low interest rate environment. In the first four months of the year investors have bid up shares of Utilities, Consumer Staples, and Healthcare to lofty valuations. Case in point, Barron's compared Johnson & Johnson (JNJ) to Cisco Systems (CSCO) a couple weeks back. Even though the networking-equipment maker's earnings-per-share gains and free-cash-flow growth over the past 10 years have, on average, bettered J&J's. The idea is that if things go belly-up, folks will stop purchasing routers before they stop buying aspirin. While there's a logic to that, the wide valuation disparity seems much more a result of market style than differences in fundamental outlook. That should make a long-term investor think twice about adding J&J at this price and ignoring Cisco.
Both companies are dominant players in their industries and possess industry-leading financial strength. Cisco is rated just A-plus, despite having net cash of some $30 billion. Their market values are $238 billion and $110 billion, respectively. Though J&J's business is somewhat non-cyclical and thus perceived as less risky, the cyclical risk associated with Cisco is mitigated by its solid incumbent position in global information technology infrastructure, a strong balance sheet, and low valuation.
Currently, Cisco trades for 10 times earnings, 2.3 times sales, and 2 times book value. J&J trades for 15 times earnings, 3.2 times sales, and 3.6 times book. One of the best features of Cisco is the dividend and dividend potential. J&J pays out 66% of their cash in the form of a dividend while Cisco pays out only 27%, so it would appear Cisco has more room to boost its payout. Cisco recently hiked their dividend 21% raising their yield to 3.2%. In the short term earnings will dictate where Cisco's stock goes, but longer term strong cash flow and the potential for more dividend hikes bodes well for Cisco's stock.