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What's Wrong With Cisco?

What's wrong with Cisco Systems (Nasdaq: CSCO)? Seriously?

That's a good question that the market, in its infinite wisdom, has been unable to figure out for nearly 15 years.

To borrow a phrase made famous by Wall Street legend Art Cashin, CSCO's chart looks like "the EKG of a potato":

I've been following the stock just for most of my career. I remember during the tech bubble days when the water cooler talk was of Cisco's "whisper number" -- the Street's general yet quiet consensus on how much the company would beat its expected earnings. Those were incredibly shortsighted days as you can see from the stock's 80% tumble during the tech bust.

But after that, something marvelous happened: The stock became a bond.

One of the tenets of Warren Buffett's stock selection process is that if a business has a strong, well-established market position and competitive advantage, its earnings (and payouts) should be so predictable that owning its stock is like owning a bond. The example Buffett usually cites is his investment in soft drink giant Coca-Cola (NYSE: KO). The Oracle of Omaha has said on more than one occasion: "A ham sandwich could run Coca-Cola."

Cisco has become one of those bondlike stocks.

Cisco is undeniably the largest global supplier of high-performance computer/Internet networking systems. If you compare the Internet and data transmission to a railroad, Cisco makes the track. And you gotta have track!

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Considering Cisco's staggering market share -- 53% share of the entire router market, and 59% share of the overall Ethernet switching market -- I would hate to be a Cisco competitor.

Data Is All -- All Is Data
The growth of electronic data transmission in our lifetime is nothing short of miraculous. The focus going forward, naturally, is on the growth of mobile broadband transmission.

Cisco is undeniably the largest global supplier of high-performance computer/Internet networking systems. The company controls 53% of the entire router market, and 59% of the overall Ethernet switching market.

It's like how Jerry Seinfeld summed it up in discussing his Web-based show "Comedians in Cars Getting Coffee" and squashing rumors about a return to television: "Why would I make a show for a screen that hangs on people's walls when I can do one that they carry around in their pocket?"

According to the International Telecommunications Union, 74.8% of the developed world's population uses mobile broadband. That number has grown 300% in six years -- but mobile broadband use in the developing world has grown more than 2,300% in that time, from 0.8% penetration to 19.8%.

Cisco sells 56% of the switches that help route that data growth -- and yet its stock lies fallow. Lucky for us...

How predictable is Cisco's earnings stream? The numbers are incredibly strong. Revenue has grown on average at a 12% rate over the last 10 years. Net income has grown at around 6%, more than twice the GDP growth of the U.S. Over the past 10 years, Cisco's average net margin is right at 20%, its average long-term debt-to-capital percentage is a steady and low 17%, and its average return on equity is 20%.

And the company currently has a $50 billion mountain of cash on its balance sheet. Last year, management boosted the quarterly dividend 466% from $0.03 to $0.17 cents.

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So why has the stock flatlined for nearly 15 years? Simple -- the company isn't turning in the 25%-plus earnings growth it was at the end of the 20th century. Data-driven technology is no longer in its infancy. It's mature, almost utilitylike. And Cisco owns nearly 60% of the market of crucial equipment components. Money can be made owning this stock for a very long time.

That said, Cisco's fourth quarter was a mixed bag. Revenue came in slightly above expectations, but the company warned that revenue would be softer by about 7% during the first part of this year due to slack global demand and turmoil in emerging markets. However, management increased the dividend another 11%, to $0.19 a share per quarter.

Cisco CEO John Chambers does not strike me as the imprudent type. So despite the downbeat forecast, the company is still quite capable of maintaining its steady pace.

In the fourth quarter, Cisco's Internet security sector revenue grew 17% compared with the same period last year. Wireless products revenue grew 15%, and data center sales grew 30%. These are significant numbers in important, rapidly growing sectors -- so investors can look for good things to happen.

Risks to Consider: The biggest risk Cisco faces is economic softness in the U.S. economy. The current rebound, though tepid, is healthy enough to offset the weakness in overseas markets. The company's best defense is its market-leading position in crucial product areas and its solid steel balance sheet.

Action to Take --> Cisco shares offer outstanding, bondlike returns and an exceptional value. Currently, shares trade at about $22 with a cheap forward P/E ratio of 11 and a growing dividend yield of 3.1%. Realization of the stocks strength should propel the forward P/E to 15, resulting in a 12- to 18-month target price of $30 -- a nearly 40% total return including dividends.

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