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Can Earnings Save Cisco from The “Chambers of Pain”?

Talking Numbers

What’s wrong with Cisco Systems?

Cisco yields a 3.2% dividend, 125 basis points above the 10-year US Treasury note. It has three times as much cash as it does debt. Its return on equity is 22.7%. Its price to earnings ratio is 10.1. Yet, had you invested in the company five years ago, you would have lost almost 20% of your money.

What gives?

“There’s old tech. And then, there’s ancient. Cisco is selling abacuses in a new age market,” says Richard Ross, Global Technical Strategist at Auerbach Grayson and Talking Numbers contributor. “People want the future, not the past.”

For Ross, the charts tell a similar story. Though it’s up a little over 8% in 2013, it doesn’t match the S&P 500’s nearly 15% return. “We call that relative weakness,” says Ross. “That’s the first sign this stock’s in trouble.”

The stock has traded in a range between $20 and $22 per share since the start of the year. Ross sees it as a complex head-and-shoulders top, a bearish signal. Ross believes Cisco will test the $20 support level and break below it to $19. “I would be a seller.”

Cisco’s negative performance also gives Ross a reason to not like it as an investment. “This is a stock that can’t even get going in one of the strongest bull tapes in the past five years. If you can’t act well in a strong tape, imagine if we had a pullback in the broader market.”

Enis Taner, Global Macro Editor at RiskReversal.com and Talking Numbers contributor, sees two fundamental issues weighing down Cisco. Bad reports from fellow enterprise sector companies IBM and Oracle have played a role but so has the market’s perception of Cisco as a hardware company. Hardware, notes Taner, doesn’t have the kind of recurring revenue software does. “It’s much more of a software company than people give it credit for,” says Taner.

Given its fundamentals such, as a free cash flow (FCF) growth of 5% to 6% per year, Taner is more optimistic about Cisco’s prospects than Ross.

“I don’t see the stock going up by 20% to 30% by any means,” says Taner. “But I certainly don’t see it declining by 20%”.

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