Cisco Refocuses to Compete in a Cloud-Driven World
The company's growth ambitions depend on a service-based model
Wall Street's Consensus Outlook Is Bullish
The market implied outlook is bullish
CSCO must achieve higher growth than in recent years
Network giant Cisco (NASDAQ:) has adapted somewhat slowly to the massive shift in IT spending, now favoring cloud-based solutions. Going forward, the company will focus on software subscriptions, cloud solutions, and anywhere work as a focus for growth.
While management is saying the right things, CSCO's has been disappointing in recent years. The consensus on expected earnings growth points to a prevailing belief that the San Jose, California-based company's turnaround efforts will not be very successful. The consensus for 3-5 year EPS growth is 5.9% pa, well below the average projected growth rate of 15.5% for the IT sector.
CSCO 12-month price historySource: Investing.com
CSCO is down 12.4% from its TTM high of $63.96 on Dec. 29, but its 12-month total return of 30.4% is well above that of the . The total TTM return for Invesco QQQ Trust (NASDAQ:) is 9.1%.
Longer term, CSCO's performance has lagged, with a three-year total return that is about half that of and the current stock price is below the level the stock reached in July 2019.
Quarterly earnings per share have been flat for the past three years and expectations for the year ahead and beyond are more of the same. While the TTM P/E of 21.2 for CSCO is low for a major tech company, the lack of earnings growth over the past three years is certainly a concern. Source: E-Trade. Green values ??are the amounts by which earnings exceeded the consensus expected level.
I last wrote about CSCO on October 21st and gave a bullish/buy rating. The main drivers of the rating were: low rating for a large technology company,
bullish consensus outlook for Wall Street and
bullish consensus outlook for the options market.
While most readers will be familiar with (1) and (2), using options to form a vision may be new.
The price of an option on a stock reflects the market's consensus estimate of the probability that the stock price will rise above (call option) or fall below (put option) a certain level (the option's strike price) between now and when the option expires. By analyzing the prices of call and put options on a series of strikes, all with the same expiration date, it is possible to calculate a probable price prediction that reconciles the observed option prices. This is called the market implied outlook and reflects the consensus view of buyers and sellers of options.
Since my last analysis was published, CSCO has posted a total return of +1.58%, compared to -3.3% for the S&P 500 over the same period.
I have updated the market implied outlook for CSCO to mid-2022 and early 2023 and compared it to the Wall Street consensus outlook.
Wall Street Consensus Outlook For CSCO
E-Trade calculates Wall Street's consensus outlook by combining the opinions of 18 ranked analysts who have published ratings and price targets for CSCO in the past 90 days. The consensus rating is bullish, as it was last year, and the 12-month consensus price target is 17.5% above the current share price. The consensus price target for 12 months is slightly higher than three months ago ($63.78). Of the 18 analysts, nine assign a buy recommendation and nine a hold.
CSCO Consensus Assessment and 12 Month Price Target Source: eCommerce
Investing.com's version of the Wall Street consensus is calculated by pooling the views of 29 analysts. The consensus rating is bullish and the consensus price target is 9.35% above the current price. The consensus price target is significantly lower than for E-Trade due to an outlier analyst with a $30 price target for the stock. Consistent with E-Trade's results, analyst ratings are almost evenly split between buy and hold.
CSCO Consensus Assessment and 12 Month Price TargetSource: Investing.com
The difference between the 12-month consensus price targets of these two sources has a major impact on the expected price increase. To try and reconcile the spread, I looked at Seeking Alpha's calculation for the consensus price target. At $63.5, Seeking Alpha falls between the 12-month consensus price targets of E-Trade and Investing.com.
The average of Investing.com and E-Trade's 12-month consensus price targets, $63.39, implies a 12-month price increase of 13.4%. Combined with the dividend yield of 2.6%, the expected total return is 16%, close to the lagging five-year annualized yield of 15.7% and well above the three-year annualized yield of 10.3%. For CSCO
I calculated the market implied outlook through mid-2022 (using options expiring June 17, 2022) and through 2022 (using options expiring January 20, 2023).
The standard presentation of the market-implied outlook is in the form of a probability distribution of price return, with probability on the vertical axis and return on the horizontal.
CSCO Market Implied Price Returns from Now to June 17, 2022
Source: Author's calculations using option quotes from E-Trade
While the market implied outlook is generally symmetrical, peak probabilities are shifting towards positive returns, a bullish indicator. The maximum probability outcome corresponds to a price return of +3.4%. The annualized volatility calculated from this distribution is 32.2%.
To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution around the vertical axis (see chart below).
CSCO Market Implied price return probabilities from now to June 17.2022
Source: Author's calculations using option quotes from E-Trade. The negative return side of the distribution is rotated about the vertical axis.
This view makes very clear the upward trend of the market-implied outlook. The odds of positive returns are significantly and consistently higher than negative returns of the same magnitude for a wide range of the most likely outcomes (solid blue line is well above the dotted red line across the left of the chart). This is a bullish outlook for CSCO through mid-2022.
Theory suggests that the market-implied outlook will tend to be negatively biased, reinforcing the optimistic view through mid-2022.
The market-implied outlook for the next 11.8 months is less optimistic, with almost equal opportunities for positive and negative returns. The chances of negative outcomes are usually slightly higher than those of positive outcomes. Due to the expected negative bias, this is still interpreted as a neutral outlook with a slight bullish tilt. The annualized volatility calculated from this distribution is 31.3%.
CSCO market Implied price return probabilities from now to January 20, 2023
Source: Author's calculations using option quotes from E-Trade. The negative return side of the distribution is rotated about the vertical axis.
The market implied outlook is bullish through mid-2022 and neutral with a slight bullish tilt for the full year. Expected volatility is stable at around 31.7%.
Summary
Although CSCO's valuation is quite modest for a major technology company, the company's revenue and earnings growth has been subpar in recent years.
Cisco is trying to catch up with the market shift to the cloud and all-as-a-service. The consensus outlook is that growth will continue to lag, but valuation offers some potential for price gains.
Wall Street's consensus outlook for CSCO is bullish, with an expected 12-month total return of about 16%. As a rule of thumb for a buy recommendation, I want to see a 12-month expected return that is at least half of the expected volatility, and CSCO simply meets this criterion using the Wall Street consensus price target and the expected volatility of the market-implied outlook .
The market-implied outlook for CSCO is bullish through mid-2022, but neutral, albeit with a slight bullish tilt, for the full year. I maintain my overall purchase rating for CSCO, but plan to re-evaluate mid-year.
