Tech giant Cisco (CSCO) has been, to say the least, a disappointing stock over the last couple of years. Lower guidance started in August of last year and by the time the company issued another earnings and profit warning in November, the drop had already begun. With downward momentum already in place, the stock tumbled, losing over 15% over the next month for a total 1 year low to high fall of over 23%. Hardly the profile of a top pick, but, partly for reasons of past performance of the stock, that is how I see CSCO.
Normally, despite a trading room background, I am more of a fundamental than technical guy. Markets, as I have said many times, are forward discounting mechanisms; what traders expect to happen in the future is far more important than what happened in the past. At times, however, some basic historic patterns emerge that cannot be ignored.
Look at the chart below. The three vertical gold lines represent the actual earnings releases, but the area of interest to me is the week or so leading up to those dates. In each case, the stock showed significant gains in the run up to the earnings date. Cisco will release their latest earnings 8 days from now, on May 14th, making at least some kind of a rally look likely.
Of course, just because something has happened three times in a row doesn’t mean that it will happen again. Indeed, a case could be made that, on a “once bitten twice shy” basis, traders are less likely to go into this release with optimism. The fact is, though, that once a pattern has become established in any market, it is more, not less, likely to be repeated. There are enough people looking at charts to see it and act on it, making a similar move almost inevitable. 5% or so over the next week would give a significant cushion for investors going into next week’s numbers.
This short term move, should it materialize, would be nice, but for me, investing in Cisco at these levels is not necessarily a short term play. It is one of those contrarian, expectation driven trades that I love. Often, as we have seen all too often over the last month or so, expectations surge way beyond reality to the upside. Forward P/Es in the hundreds are rarely justified, but occur quite frequently. Sometimes, however, the reverse is true.
As Cisco has repeatedly lowered the market’s expectations, so forecasts for future profit and revenues were cut by the plethora of analysts who follow the stock. Interestingly, those cuts in the forecasts have now stopped. Recommendations are now generally positive, and for good reason. The stock is now cheap.
In a world where companies that have not yet demonstrated the ability to turn a profit are worth hundreds of times the wildly optimistic analysts’ estimates of future earnings it is hard to ignore one that is trading at around 10 times earnings estimates that themselves are conservative. This was the logic that led me and others to turn positive on Apple (AAPL) below $500 and that one is working out OK. None of this means that Cisco is a slam dunk long term investment opportunity, but it does make it likely that the worst is over in terms of the price of the stock. That, in turn, makes it, despite recent performance, a relatively low risk bet.
Poor performance and disappointing, even negative growth are now fully priced into both estimates and multiples. Short of another massive guidance downgrade it is hard to think of anything that Cisco’s management can say that will have a major negative effect. News and views don’t even have to be particularly positive to elicit a positive response, just not disastrous.
There could even be room for some good news to report on a couple of fronts. Firstly, as the company begins to roll out their “Nexus 9000” switching product line. Switching as a business line has suffered from the decelerating growth that has plagued the company, but is still growing. A new product line could well accelerate that growth and as switching accounts for about 30% of Cisco’s sales, any positive news on that front will have a significant effect.
There is also cause to believe that the last couple of quarters’ pessimism has been based to some extent on temporary problems that have passed. Government shutdown and the prospect of slower Chinese growth were big factors in the poor results and negative outlook at the end of last year. The first didn’t happen and the general pessimism about the second has been tempered somewhat over the last couple of months.
In many ways, the positive case for Cisco consists of a whole bunch of ifs and maybes. The fact remains that the company has disappointed. Some of that may be cyclical, but some is certainly down to mistakes. They came late to the cloud computing arena and are just recently entering what is now looking like a very crowded space, for example.
Despite that, however, CSCO looks to me to be one of the best opportunities in tech right now. The bar for success is being set very low by the market and after several quarters of bad news and worry, just limping over that bar will probably be seen as encouraging. Add to that the history of appreciation in the run up to earnings and you have a trade that, far from being risky as first appears, seems to have very little downside, but significant upside. If you know me at all, you know that that is a combination that I can’t resist.