Entry for Nov 7, 2007

11/7/07


Cisco Systems

Market Capitalization $203B

Close: 33:08

Growth Rates:

Current Quarter Growth Estimate: 16.1%
Next Quarter Growth Estimate: 15.2%
This Year Growth Estimate: 17.2%
Next Year Growth Estimate: 16.6%

Peg Ratio: 1.49
Valuation:

Current Year P/E ‘08: 20.89
Forward P/E ’09: 18.00

Bullish Fundamentals:
- Current and next quarter growth moderate to strong with 16.1% and 15.2% respectively, positive in short term due to stronger current quarter growth compared to its industry current quarter growth (13.5%).
- Positive for the longer term, this year’s overall growth at 17.2% is higher than its industry (8.1%), sector (17.0), and S&P 500 (6.1%) for the year.
- In terms of forward P/E cross comparison of competitors CSCO may appear to be under valued with forward P/E of 20.71, while ALU has a forward P/E of 37.87, NT 32.3 and JNPR 41.62
- Forward P/E of CSCO (18) in relation to Industry (24.88) and Sector (24) is relativity undervalued
- In a basic sense CSCO would be overvalued with a PEG of 1.49, but compared with its competitors it is much lower, ALU has a peg of 3.36, NT 4.02, and JNPR 2.02.
- 15% growth in total revenues from 05 to 06 and 18% increase from 06 to 07.
- 31% increase of net income from 06 to 07.
- Steady cash flow
- Softness from US segments can be offset by demand from emerging markets.
- SMB segment continues to be healthy
- SFA segment has shown strong demand with IPTV setup boxes

Neutral Fundamentals:
- Static EPS the past 60 days, showing hesitancy sentimentally (reflecting in technicals)

Bearish Fundamentals-
- Growth may not sustain
- Sustaining high growth and % of total revenues will be harder to attain as technology sector improves on whole, and bargain hunters will be searching for better buys.
- Estimates are easy to miss, with tight income statement, risk increases with stronger fundamentals
- 18% increase in total liabilities contrasting to a 22% increase in liabilities, watch to see that liabilities does not exceed assets.
- Disparity between high and low earnings estimates, 1.48 to 1.65 (hesitancy).

Fundamental conclusion:
Overall CSCO presents average to fair valuations not significantly under valued or highly overvalued. The income statement remains strong, while there maybe questions for future growth as the technology sector improves, and with bargain hunters looking for better buys with less large companies.


Technical Analysis:

Bullish:
- CSCO presents a nice chart over all from 1990, After peaking out at 77 and bottoming around 10 CSCO has been working its way back up to resistance, with new long term support levels at 20-25 (between 2004 and 2006).
- Current sentiment in technology will allow it to reach support levels
- RSI alone indicators higher prices
- 3 white soldiers with increasing volume
- Price support with prices above the 50, 100, and 200 SMA (useful as a measure of non institutional investor decisions).
- 50 SMA is close the median of the prices, every time there is divergence of the price going above CSCO has rallied, early may 2005 prices went above the 50 SMA and trended into late June with (about 16% gain), February 2006 into early late march when prices went above there was about a 22% gain, Early August 2006 into early January 2007 about a 52% gain. Mid June to Early October 2007, when prices went above the 50 SMA, 19% gain (the low that pierces the 50 SMA in mid August can be accounted for by the significant bearish sentiment as indicated by the 3 black crows that preceded it, thus only account for as a whipsaw as the fundamentals warranted the continued overall uptrend).
- Evening star formation over the past 4 days
- Price channel from June 2007 till now is still legitimate if one considers early the price pierce in early august to be a whipsaw.

Bearish:
- Though with strength in technology declining volume may not be able to push through with the slowing momentum.
- RSI is getting closer to top standard deviation (depending on sentiment, CSCO trends sideways to down as RSI approaches the top limit, it is possible the extreme bullishness may push it above further)
- Price piercing of upper standard deviation in Bollinger band (20, 2), significant indication of prices trading in the bands today.

Technical’s point to stronger growth in the longer term. Significant back testing confirms this though along with above average volume ahead of earnings. Though on the short term the RSI and Bollinger band points to short term downside pressures. Once these pressures are overcome, a continued uptrend will hold, as confirmed by the trading channel from June till present.

Sentiment: one can ignore sentiment on buy rating analysis as, there are many buy ratings when CSCO trended downwards.


Risk:
- This extreme bullishness sets up extreme fragileness giving no room for slight miss on expectations even if positive regardless on earnings report.
- Market Volatility following media driven fundamentals opposed to underlying fundamentals
- Credit liquidity issues, though on a whole technology sectors has been resilient to this. Though interest rate risk is significant with volatility, though if interest rates are on the downside, this can alleviate some debt with refinancing. Though if economic conditions are significant with inflationary pressures, debt can be more straining.
- Using buy/sell sentiment as an indicator, as the majority of the buy sell ratings are all neutral to strong buy with very few sells. All the buy ratings were still in place despite poor the intermittent poor performances.
- Possible overvaluation, recent buybacks artificially inflations P/E, as reflected in a .71 LT debt to equity ratio. Buyback can be seen to give more power to insiders. Possible candidate for window dressing based off recent sentiments.

Overall Fundamentals and technical’s are in agreement. I do not however like the overly bullish tone coming from analyst on this security. The sound fundamentals should be inline with estimates, though some of the fundamentals maybe inflated as indicated in the risk section. This inflation may be indicated by the price piercing of the Bollinger band indication short term volatility more to the downside. Indicating, one should buy on a pullback. Overall fundamentals and technical’s warrant a long term buy. Short term volume has picked up, but not be enough in the short term to continue the upward trend. A temporary dip to the downside would not be surprising and is expected by my opinion. Though if earnings do come out stronger than expected, there is no doubt the upward trend will continue.

Overall: long term buy, suggested to buy on a pullback.

If one owns securities already, writing a covered call of a Nov 17 at .90 is suggested. A straddle is not suggested as earnings are expected to be inline according to sentiment. If earnings do miss a covered call should absorb some of the losses.

Analyst: Alexander Lê