Don't buy on Cisco's home run

By Robert Walberg

There are home runs and then there are those towering, awe-inspiring shots that you don’t soon forget.

Cisco Systems (CSCO, news, msgs) delivered an earnings report today that, for investors, fits in the second category. The company hit a monstrous home run with 25% growth in sales and 28% growth in earnings. Considering Cisco’s size and the competitive nature of its marketplace, those are the kind of numbers that make Wall Street stand up and cheer.

That’s just what investors did in after-hours trading, sending the stock up 8.3% to $27.19. Cisco is now up 59% since bottoming in early August of this year.

Can the relentless, late 90’s style climb continue? While additional gains are probable over the long-term, here's why today’s pop provides a perfect opportunity to take the money and run.

Cisco isn't cheap

Consider the valuation. Assuming Cisco opens tomorrow’s trading at or near $26.50, the stock would be trading at 20.9 times current-year estimated earnings of $1.30 per share (adjusted higher for the recent quarter’s better-than-expected numbers) and about 18.1 times next year’s consensus figure. That's not out of line for an industry leader exhibiting strong momentum, but it isn't cheap. By comparison, the S&P 500 trades at about 16 times forward numbers, with similar earnings growth potential over the next few years.

Investors also need to look beyond the headline figures and project how Cisco will sustain its current momentum. Considering that margins are being pressured by intense price competition in the industry, especially in the router business that still makes up a considerable percentage of overall revenues, Cisco may have a tough time living up to what will certainly be inflated expectations for the next couple of quarters.

While gross margins (GAAP basis) of 63.9% were fractionally below guidance of 65%, the disappointment was more than offset by the stronger sales figure. Cisco also upped its revenue guidance for its second quarter to $8.219 billion to $8.285 billion, above the analyst consensus of $8.05 billion. The risk for Cisco now is that it doesn't take much to knock a stock when expectations become universally bullish.

The other problem for Cisco is its series of bullish quarters (it has topped estimates for at least four consecutive quarters). The company will run into tough comparisons early next year, and since the market is a forward-looking entity, it won’t be long before investors start to concern themselves with the prospect of slowing growth. That's an issue investors need to be aware of before they pay over 20 times earnings for a stock trading at its highest levels in nearly three years.

Smooth sailing for the business

As for business overall, there wasn’t much to complain about. Cisco posted double-digit order growth throughout its divisions and across geographical regions. U.S. order growth was pegged in the upper teens, with growth topping 40% in emerging markets. The company expects order growth to improve slightly in the quarter ahead.

The integration of Scientific-Atlanta has also gone very smoothly so far, as that unit helped bolster revenues by $584 million in the recently completed quarter. Cisco’s efforts to diversify its business have reduced the risk from a downturn in corporate spending and have improved its reach into the consumer market. The consumer segment is extremely competitive so the move could pressure margins further, but for now CEO John Chambers and Co. get credit for putting Cisco in position to enjoy strong double-digit sales and profit growth. In the world of mega tech companies such as Intel (INTC, news, msgs), Dell (DELL, news, msgs), IBM (IBM, news, msgs)and Microsoft (MSFT, news, msgs) that has been no easy task.

The bottom line: investors should look to sell into the current strength and wait for the stock to dip back into the mid- to low- $20s before considering entering any long positions.

Robert Walberg is a financial writer based in Chicago and a regular guest on CNN's "Moneyline." He was formerly chief equity analyst at Briefing.com and ran for Congress in Illinois in 1994.

At the time of publication, Walberg did not own or control shares of any companies mentioned in this article.