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Despite Slowing Core Businesses, Cisco Systems Is a Buy

- By Naman Shukla

Cisco Systems Inc. (CSCO) is a worldwide leader in information technology and networking. The company rewarded investors with healthy returns in 2016 as the stock was up approximately 12%. Moreover, the stock has displayed strong signs of upward momentum heading into 2017 as it is up nearly 9% year to date.

Cisco reported strong second-quarter results in February. For the quarter, the company recorded earnings per share (EPS) of 57 cents, beating the estimates by one cent. Revenue came in at $11.60 billion, again beating the estimates by $50 million. That figure, however, signifies a decline of 1.7% year over year.


The company generates the majority of overall revenue from its core hardware business (routers and switches). In 2016, sales of routers plunged 4% while switches' sales remained flat. Furthermore, it is highly likely the company's core business segment will endure facing problems in the future as cheaper rivals such as Huawei begin to rise.

To overcome this issue, the company is diversifying its revenue stream. Currently, the company is aggressively focusing on the internet of things (IoT) market as it is projected to grow to $661.74 billion by 2021. Currently standing at $157 billion, the market would grow at a compound annual growth rate of 33.3% throughout the forecasted period.

In 2016, Cisco acquired Jasper Technologies, a leading provider of cloud-based IoT service platforms. To further strengthen its IoT and applications business, the company recently bought AppDynamics for $3.7 billion. AppDynamics will provide a tool to Cisco for monitoring the performance of applications, irrespective of the application delivery platform.

As an outcome, the acquisition of AppDynamics signifies the next big step in the company's transition from hardware to the software that is now driving practically all advancements in technology. These acquisitions, along with the company's own innovation in the space, have helped it to introduce several new innovative products and bundles into this market.

Apart from the IoT business, the company's security business also continues to perform well as the revenue generated from the cybersecurity segment surged 14% on a yearly basis to $528 million. The company gained more than 5,500 next-generation firewall customers, bringing its total count to 67,500.

Recently, the company also introduced its new cloud security platform called "Cisco Umbrella", the industry's first secure internet gateway, which will enable users to gain secure access to the internet.

Cisco began paying a dividend in 2011. Since then, the company has successfully managed to increase its dividend every year. The company recenlty increased its quarterly dividend from 26 cents to 29 cents, representing 11.5% growth. Even after the increase, the company pays out approximately 55% of its earnings, suggesting it still has plenty of room to grow its dividend in the future.

Moreover, the company generated $12.4 billion of free cash flow (FCF) in the previous fiscal year. Despite the slowing growth in its core businesses, the company managed to generate strong free cash flow, which highlights its ability to grow well even in difficult times. Accordingly, Cisco's strong free cash flow will help it to invest in other meaningful growth areas in the future.

Conclusion

Despite the slowdown in its core businesses, Cisco performed really well in 2016. The company is diversifying away from its core businesses, which will reap fruitful results in the near future.

Moreover, the company also offers a rock-solid forward dividend yield of 3.51%. The stock currently trades at a price-earnings ratio of almost 17, considerably lower than the industry average of 25, which clearly suggests it is cheap at the current market price.

As a result, investors should consider adding Cisco Systems to their portfolios as its future prospects look strong.

Disclosure: I don't hold a position in the stock mentioned in this article.

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This article first appeared on GuruFocus.