Major benchmarks have become volatile in the past few days, and 2020 has not treated Cisco Systems (NASDAQ:CSCO) stock all that well compared to many other tech names. In 2020, the stock is up about 2%. On the other hand, the PowerShares QQQ ETF (NASDAQ:QQQ) has risen about 8%. CSCO is expected to report its Q2 earnings after the market closes on Feb. 12.
During this new decade, I expect the stock markets to be led by tech stocks, and I think CSCO shares have value for long-term investors. However, just before the company’s earnings report, its shares are likely to be volatile with a downward bias. Therefore, I’d urge investors to be cautious about Cisco in the near-term.
What to Expect from CSCO’s Earnings Report
The company dominates the networking and communications equipment markets. Its products and services help customers transport data, voice and video traffic.
When it reported its Q1 earnings in November, its revenue and earnings exceeded analysts’ average expectations. In Q1, its revenue grew 1% year-over-year to $13.2 billion.
Product sales account for about 75% of its revenue and Services generate about 25% of its sales.
In Q1, the revenue of all of its Product categories increased YoY, with Applications jumping 18%, Security surging 11%, and Infrastructure Platforms climbing 9%.
Overall, the company’s Q1 results were solid. In Q1, Cisco paid off more than $6 billion of its debt, reducing its interest expenses in the process.
However, CSCO predicted that its revenue would decline in Q2 as its customers hit the pause button. Orders from emerging markets were especially weak, as many of Cisco’s customers were not ready to make big investments in networking infrastructure.
When a tech company cuts its guidance, its stock drops rapidly. And that is exactly what happened to CSCO in November following its earnings report.
Cisco’s shares are likely to be volatile following its Q2 results as investors compare its performance with its guidance.
The Tailwinds Behind CSCO Stock
Over the past decade, Cisco has, at times, found it difficult to grow its top line. And its stock price reflects its growth challenges, as in the past 12 months, the shares have been virtually flat.
Yet Cisco’s management is working to transform its business, as the company is diversifying into software and cloud support services. Many analysts have welcomed this strategic move that is likely to increase the company’s revenue, with most of those gains coming from recurring, high-margin, cloud-related, subscription services.
The company’s goal is to generate about 30% of its total sales from software by the end of FY20. Its Q2 results will enable the Street to measure its progress towards that goal.
Also, since 2020 is expected to be the year when 5G becomes more mainstream, demand for products that support 5G wireless systems is expected to boost networking vendors. Cisco stock should benefit from that trend in the long-run.
CSCO has more than $33 billion of cash and short-term investments enabling it to make acquisitions that could help it increase its revenue. Recently, the company has closed on acquisitions of customer experience management company CloudCherry and speech recognition company Voicea. CSCO’s past and future acquisitions will help it expand its ecosystem.
As its global geographical reach is rather broad, the company may be spared any further damage that may be caused by negative developments related to China, be it further trade wars or the most recent viral epidemic. For example, the company is expecting to triple its customer base in India, where about two-thirds of all small- and medium-enterprises (SMEs) have no online presence.
Going forward, in addition to Cisco’s strong balance sheet, its management’s strategic efforts to increase its revenue and customer base are likely to act as powerful catalysts for the shares.
CSCO Stock’s Valuation
The stock’s trailing P/E ratio of about 17 has also put it on my radar screen. In comparison, the trailing P/E ratios of Advanced Micro Devices (NASDAQ:AMD), Nvidia (NASDAQ:NVDA), and Texas Instruments (NASDAQ:TXN) are 170, 72, and 25, respectively.
Furthermore, CSCO stock’s current annual dividend yield of 2.9% makes it attractive for dividend investors, for whom valuation matters. Since the company’s earnings and free cash flow will enable it to easily pay its dividends, I do not expect it to cut its dividend in coming quarters.
However, I am a bit concerned about the stock’s current price-sales ratio of over 3.9. Analysts prefer a low P/S multiple and ideally like the ratio to be below one. However, a P/S ratio between one and two is more common. To put the metric into perspective, the S&P 500’s average P/S ratio is 2.3.
Cisco stock could decline if the company’s Q2 results were badly impacted by China’s current difficulties. But any significant decline by CSCO stock would create a buying opportunity.
The Bottom Line
I am bullish on the long-term outlook of Cisco stock, as its growing subscription revenue will likely help boost the shares. However, although the fundamentals of Cisco may look quite appealing, I’m expecting tech stocks to be hurt by volatility and profit taking in the short-term.
The shares may soon drop towards $45. If the company’s earnings report is weak, they may even trend closer to $42.5 level.But I expect Cisco to bounce back from any potential decline before too long.
As of this writing, Tezcan Gecgil holds CSCO covered calls (Feb. 14 expiry).