Cisco’s Growth Story Revised

The most amazing thing about Cisco’s earnings report is that the stock is holding up so well this morning.

Cisco is trading at about 18.75 this morning, down about 50 cents from the close. That’s not bad, considering that the company’s near-term and long-term growth story were both revised downward last night.

Cisco met pro forma estimates of 2-cent earnings, but revenues of $4.3 billion were at the low end of analyst estimates, and the company’s bottom line was apparently helped by a reduction in R&D spending. The company guided next quarter’s revenue estimates down to $4.1-$4.3 billion from current estimates of $4.3-$4.4 billion. And most importantly, the company backed off of its long-term growth projections of 30%-50%.

CEO John Chambers said there are some signs that the U.S. market is stabilizing, particularly in the enterprise segment, but that the U.S. service provider market and Europe and Asia remain weak. He said a bottom in the U.S. is possible in the next 1-2 quarters, but that European and Asian weakness could cause another leg down in the U.S. market. Orders and shipments drew even in the quarter, a positive.

Before last night, analyst estimates for the company’s fiscal year ending in July 2002 were for pro forma earnings of 28 cents a share. This morning, analysts are slashing those 2002 earnings estimates to 13-18 cents a share, giving the company a forward price-to-earnings ratio of more than 100. Even if the company could grow at 30%-50% a year over the long-term, it would still be expensive at its current price.

But the company backed off that long-term projection last night. During the Q&A session on the conference call, Chambers said that “only time will tell” if the company can grow at 15%-20% or 30%-50%. Former company officials have been saying privately that15%-20% is more realistic.

So what is a fair value for CSCO stock? Based on a strict price-to-earnings growth ratio reading, the stock would be a bargain at about $3-$5 a share, or 20-30 times 2002 estimates.

Ken Lee’s complex Trouncing the Dow valuation method gives the stock a current low and high valuation of 6.44 and 15.32, respectively – but that valuation range will likely come down after last night. You’d probably do better over the long run owning Merck at these levels.

And Cisco’s technical picture remains weak. The primary pattern in play remains the head-and-shoulders top (see chart below), which gives the stock long-term downside potential to $13 or lower. It would take a strong move and close above $20.75 to change that technical picture.

But for some reason, investors remain hopeful of a strong turnaround for Cisco in the not-too-distant future. The number of August $20 calls – option bets that the stock will close at that price in two weeks – are at astronomical levels, showing that hope for a rebound at Cisco remains high.

But hope, as they say, is not an investment strategy. The odds are higher that at some point, investors will be able to pick up CSCO stock at more attractive levels.