Cisco Could Lag Peers as Economy Rebounds

• ByDavid MacDougall, TSC Ratings Analyst
• On 8:15 am EST, Tuesday November 10, 2009

SAN JOSE, Calif. (TheStreet) -- Cisco Systems helped give the market a shot in the arm last week when it posted better-than-expected quarterly results.

The San Jose, Calif.-based company reported a profit of 36 cents a share for its fiscal first quarter, topping the 31-cent estimate of analysts. Sales sank 13% to $9 billion, beating expectations for $8.7 billion. Unlike some companies that relied on cost cutting to exceed estimates, Cisco managed to stabilize its sales.

Cisco's products make up the bones of computer systems. Its strong results suggest spending is ramping up as companies look to upgrade infrastructure, a sign that the economy may be improving. Sales projections for a 1% to 4% gain during its current quarter probably left some investors wondering whether they should expand their holdings.

There are several reasons for investors to jump on Cisco shares, which we rate "buy." With a price-to-earnings ratio of 16 versus an industry average of 31, the stock is cheap. Tech companies traditionally trade at elevated multiples because of their growth potential.

The stock has run up 37% during the past year, beating the S&P 500 Index's 22% gain, but trailing the 50% advance of the S&P 500 Information Technology Index. It's the fourth-best performing member of the Dow Jones Industrial Average this year. With a beta value of 1.2, the stock is not much more volatile than the broader market.

Big investments in research and development usually hurt tech companies' balance sheets, but Cisco's financial position is enviable. A current ratio of about 3.4 and low debt make it fairly secure.

There are also reasons to pause before buying. Cisco shares offer a stable investment, but gains might lag those of competitors.

As the economy improves, demand for tech equipment and software will increase in North America and Europe. However, the most explosive growth will come from emerging markets such as India and China.

Cisco generates about 80% of its revenue from North America, Europe and Japan. Emerging economies account for only 9.6% of the company's revenue. This suggests that Cisco is at an immediate disadvantage based on its regional focus.

Compared with rival 3Com, Cisco's regional breakdown looks painfully conservative. 3Com generates about 50% of its sales in China, while North America accounts for 18%. 3Com is more aligned with the world's hot growth areas, putting it a better position to benefit when the economy rebounds.

Determining a company's regional focus is an important step in forecasting performance. Cisco stock is trading at bargain prices, but the company might lack the right mix for the shares to soar during the recovery.

-- Reported by David MacDougall in Boston.

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