There it was. Sitting on the desk of my trendy hotel room in Seattle. Black. With a discrete Cisco Systems (CSCO, news, msgs) logo.
A telephone, of course.
But also a hot stock tip for anybody paying attention. And this phone isn't an isolated stock tip either. You can easily find stock tips in the technology sector just by keeping your eyes open as you run through life.
And it's certainly worth paying attention right now, since technology stocks are leading the market and the best of them look to be especially well-suited to profit from the new, post-recovery world that I described in my previous column, "5 rules for post-recovery investing."
In this column, I'm going to tell how you can find great technology buys by just paying attention as you live your life. And I'm going to identify the five to put on a watch list if, like me, you remain skeptical about the current rally -- or to buy if you're more optimistic than I am.
A way to focus your research
How does this work? What can you learn about investing by paying attention in your daily life?Let's take the example of what you could have learned if you had simply paid attention to the phone you'd used over the past 25 years or so.
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I'm old enough to remember the black, absolutely reliable -- and so heavy and solid that you could use them to crush walnuts -- phones produced by the Western Electric subsidiary of AT&T (T, news, msgs) before the 1984 breakup of that company. In the intervening years, you would have learned:
- To stay away from AT&T as you saw more and more of the phones you and your neighbors used come from other companies.
- To pay attention to newer names such as Lucent Technologies and Nortel Networks (NRTLQ, news, msgs). (I've got a Nortel phone on my desk as I write this.)
- To invest in the rise of the cell phone companies when you noticed more and more of your friends using wireless phones at home.
- To invest in the rise of Internet protocol telephony (the Cisco phone on my hotel desk) as phone service over the Internet grabbed a bigger and bigger share of the traffic and equipment markets.
What you notice by paying attention gives you a way to focus your stock research. So, continuing my hotel phone example, with a little research you'd learn several things about Cisco, the 800-pound gorilla of the market for networking equipment and software:
- It recently pushed into new markets for Internet telephony plus home networking, Internet security and storage, and Web-based conferencing.
- Revenue is projected to fall 5% to 10% in the fiscal year that ends in July -- because of lower spending by telephone companies and other network operators -- before picking up to show 5% growth in 2010. (And you'd discover that 5% growth is still way below the company's target of double-digit revenue growth.)
- The company has remained profitable during this recession, produced $5.9 billion in cash flow from operations during the quarter that ended in January and was sitting on $29.5 billion in cash at the end of the quarter.
- Using that cash and its relatively valuable stock, Cisco continues to pursue its long-term strategy of using smaller acquisitions to acquire technology and products it can push through its superb distribution system. A good example was the 2007 purchase of Internet meeting and collaboration software leader WebEx for $3.2 billion.
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Where should you invest?An International Monetary Fund report looking at recoveries from credit crunches back to 1970 says that companies with low debt and hefty overseas sales have grown faster. Those are the companies to look at, Jim Jubak says. (April 27)
After that research, you could spend some time thinking about how Cisco fits into the post-recession, slow-growth paradigm that I laid out in my previous column. You'd likely conclude that Cisco would actually gain an edge from that kind of economy, because many of its products -- from Internet protocol telephony to Web conferencing to its recent entry into the market for blade servers for data centers -- offer customers a way to cut costs while retaining or improving functionality. That's a solid value proposition in an economy where lots of customers will be looking for value.
Then you'd probably spend some time looking at the price trends in the market. If you did, you'd notice that technology stocks were showing relative strength by hanging above their January highs (in contrast to sectors that are fighting to get back to January highs). You'd also see from your study of the charts that Cisco shares were near resistance levels set by their 200-day moving average and their April high of about $18.50.
The relative overvaluation of the stock on its price-to-sales ratio and its relative undervaluation on its P/E ratio could be explained by Cisco's higher-than-average profitability. With an operating margin near 26%, Cisco is better than the average company at turning sales into earnings.
None of that tells you whether the stock is reasonably priced. To figure that out, you might look at the average P/E ratio of the past five years. Because the average was 21.6, you could conclude that Cisco, at 14.1, was undervalued, since the price in the future will climb until Cisco trades again at something like 21.6 times earnings. Or you could conclude that the lower P/E ratio was a logical reaction by investors to the company's falling earnings. Wall Street analysts now think Cisco's earnings will fall 23.2% in fiscal 2009 and 6.3% in fiscal 2010.
Setting a target price isn't a science. Where your target winds up is a result of the assumptions you make going in. I like to check the range of price targets for a stock and compare that with its current price. For Cisco, the range for a 12-month target price now seems to fall between $16 and $31 a share. At a recent $18.50 or so, Cisco has been trading above the most pessimistic target, but not by a great deal. Depending on your read for the market as a whole, that means Cisco is toward the cheap end of reasonable but not a compelling buy if you think, as I do, that this rally will yield to a correction in the next month or six weeks.
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