At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.
But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.
Alas, poor Cisco, (we thought we) knew it well
"Better late than never," goes the old saying. But from an investor's perspective, I really would have preferred it if all the analysts who turned suddenly cold on Cisco (Nasdaq: CSCO)yesterday ... had done so before the company surprised investors to the downside, rather than after the fact.
Ah, well. "If wishes were fishes ..." (There's another old saying for you.) But the damage is done. Now that it's too late to too anything about it, Wall Street has finally come to agreement that Cisco is no longer worth buying, as first Deutsche Securities, then Lazard, William Blair, and Wunderlich -- all lined up and took turns taking potshots at Cisco, disavowing their earlier optimism, and downgrading the shares to "hold" (or its equivalent). One of the few analysts who had shown caution pre-earnings, Barclays, turned even more cautious post-earnings as it lowered earnings estimates going forward.
What's got 'em feeling so cynical about Cisco? Take your pick. There's the impression that among the tech bellwethers, Cisco is starting to look like the odd man out among better-performing peers Intel (Nasdaq: INTC) and IBM (NYSE: IBM). The fact that Cisco admitted to losing set-top box market share to rival Motorola (NYSE: MOT).The strong likelihood thatJuniper (Nasdaq: JNPR) and Hewlett-Packard (NYSE: HPQ) are making inroads in Internet switches, while Riverbed and F5 Networks (Nasdaq; FFIV) nibble away at the networking niche. With the threats to it mounting, it seems the consensus on Wall Street now reads: "Hold Cisco. Don't buy this stock."
I disagree. I think now is precisely the right time to buy.
Let's go to the tape
Yesterday, my Foolish colleague Morgan Housel took issue with the "stupidity" of Wall Street punishing Cisco for beating earnings estimates -- but not beating them by a sufficient margin. Me, I've got a slightly different perspective. I'm just plain disappointed in the short-sightedness of the analysts making the downgrades today.
Honestly, Fools, these folks should know better. After all, we're not talking about a bunch of hacks here. With the sole exception of laggard Lazard, the bankers downgrading Cisco this week rank in the top 10% of those we track on CAPS: Barclays leads the pack, placing in the 94% percentile of CAPS members. It's followed closely by William Blair at 93%, while both Deutsche and Wunderlich sport respectable 90-th percentile ratings.
Two wrongs don't make a right call on Cisco
Now, it's certainly understandable that they would be disappointed in Cisco's promising only low-single-digit revenue growth this quarter, when most people had been expecting 13% growth. Still, given these analysts' own long-term outperformance, I'd have hoped they'd been able to look past a couple quarters' weakness at Cisco, and see the long-term promise in this stock. But, since they appear unable to do that, I'll lay out the case for you myself.
Pre-earnings, Cisco was a $139 billion stock with $28 billion net cash -- an enterprise valued at $111 billion. With $9.2 billion in trailing free cash flow, the stock looked almost precisely fairly valued based on consensus estimates of 12.5% long-term earnings growth. It was the very definition, therefore, of the kind of stock you would want to "hold" onto for the long-term, but not "buy." And yet -- that's just what Wall Street told investors to do: Buy more Cisco stock. Clearly, that was the wrong call to make; there was no upside to be had, absent the kind of massive, estimates-boosting earnings beat that Cisco eventually failed to deliver.
But while Wall Street was wrong to recommend buying Cisco before earnings, they've now compounded their error by waving investors away from the bona fide buying opportunity that's appeared in the wake of Thursday's sell-off. Because the cold, hard truth of the matter is that, almost nothing has changed about Cisco's story this week -- nothing but the stock price, which has become significantly cheaper.
Based on yesterday's results, free cash flow seems to be holding steady at $9.2 billion. Cash levels have dipped a bit, reducing net cash levels to $27 billion -- but at the new and improved market cap of $117 billion, that means that the enterprise-known-as-Cisco is now valued at the low, low price of just $90 billion. In other words, what we have here today is:
- A company selling for an enterprise value-to-free cash flow ratio of less than 10.
- A company that -- whatever it does next quarter or the one following -- Wall Street stillexpects to grow at better than 12.5% per year over the next five years.
- A company whose CEO boasts that he can do even better than that, posting long-term growth rates anywhere from 12% to 17%.
My most conservative estimates therefore tell me that, far from being less attractive than it was earlier this week, Cisco's sell-off has now taken a fairly priced equity, and offered to sell it to us for more than a 20% discount to its intrinsic value. And that's if CEO John Chambers is wrong about his company's long-term growth prospects, and Wall Street's more conservative 12.5% rate is the right one.
© 2010 UCLICK L.L.C.