I just made some comments on Cisco. I also take this opportunity to mention that it’s the stock I have been adding to lately (last time @15.12 a few weeks ago). I originally made these comments in a Gurufocus article written by a faithful reader to whom I here greet. They got so big that I prefer to post them in this blog in order to keep a log of my investing history and thoughts on what I hope to be a great investment.
************** Comment 1 *************
The incentive to the employees/management is for the stock to reach at least 20% to 30% over 22 for them to earn serious money. So as I see it employees/management will do anything possible for that to come true. I see sometimes a big number of options with strikes much over the current price as a great margin of safety and an opportunity instead of a problem. Due to the incentives they produce: management/employees will do whatever they can to avoid losing them.
Why a possible margin of safety there ? :
Because for the options to be exercised the stock has to go up to over 22 (average strike price) from here to 3 years (the maturity average date) and even then employees will gain almost nothing since they will exercise at that same price in average as the options they were granted.
The stock has to go substantially over that value to “hurt” shareholders, and even then it is by no way logical to think that shareholders are “hurt” since the price could have gone up also because of motivated management and owner oriented employees due to the fact that they have options. If it just reaches 22 or a bit over and the options get exercised the company gets 22/share anyways so there is share dilution but its fully compensated by the cash received when the options exercised. There is no way by then to know if total share count will increase since it could be decreasing more due to buybacks, maybe even more now due to lower prices. And if history holds total shares will be going down.
************** Comment 2 *************
Wal-Mart and Coca-Cola also went nowhere for 10 years, all were talking about employees being enslaved at WMT, Coca-cola making you fat, sugar and gas drinks disappearing … But in both cases shares kept going down while people kept consuming, and earnings kept growing. It was the time to accumulate. Until the stock recovered ! Cisco I expect will be the same story, don’t know when, 1, 2 years who knows, I dont even care much since I’m not planning on selling. But as long as the internet exists and their moat remains their stock price will sure catch up with earnings and I’ll keep holding.
Problem with Cisco is that it was massively overvalued so it went down which is normal but now most people think it went down because of other reasons and blame the CEO or whatever they can find. As I see it its a great CEO, honest and conservative. I specially like how competitive he is. It’s exactly what Cisco needs. Now going strong into cloud and taking business out of Dell and HP on servers.
But the fact, despite of the share drop, is that earnings are up; margins are big; cash flows are amazing; cash has grown to 35 Billions or more from a low base in that same period. It has no net debt, on the contrary. Business is international and does not depend (fortunately) on the USA only. Competitors are very restricted, even though last year they were used to justify the low share price, now just one year after those same competitors did very poorly.
Even in China Cisco beats the heavily government subsidized competitor Huawei which are now indebted up to their neck and shooting in several different directions.
Finally the shares outstanding: they are drastically down even including compensations. Fact !
And the great thing is that all that happened while the stock went down and I have had time to accumulate at lower prices so I hope it continues for a long while.
At the end it all about the risk/reward if you make a correct calculation you should do Okey. Remember the words of a great investor (by the way Tweedy Browne also has Cisco shares):
“Investing is not a natural science but rather a social science. So, it’s never purely empirical; what you are trying to do is everything you possibly can to enhance your probabilities of being right more often than being wrong.” – William H. Browne
************** Comment 3 *************
Sure the strike price moves with the stock price. So if the stock goes to 35 they’ll be receiving options with strikes over that price too.
Same goes for buy backs they also buy at low prices and even more I hope.
Fact is that the cash and balance sheet have been extremely fortified while the stock has dropped like hell in the last 10 years. You see all kind of reasons why flying around, nourished and reinforcing themselves by a falling stock, disregarding fundamentals. I’ve studied them all before I invested and keep up to date. The usual reasons given to justify the falling share price are: bad CEO, crappy acquisitions, extreme competition, wrong buy backs, inefficient management structure, you name it. All try to justify and adjust to the share fall but none imposes a serious risk in my view, certainly not at this levels. While I studied them all I made up my mind that the company market price is a hidden gem now more then ever in its history, so I jumped in before it gets adjusted to it’s reality. I see mainly one reason of why the stock sucked and the ones who bought at higher prices got creamed: because the company is great which lead it to an extreme overvaluation fueled along with the biggest technological bubble ever, and it fell to the subsequent extreme after the bubble burst. I have seen that “bubble and burst” story before and it can take a long time to turn around, but on the long run fundamentals win. I see it always, even nowadays, and I’m sure I will see it again, and fortunately because if the stocks behaved efficiently I would have no job investing.
Csco was built on acquisitions, it is precisely because of them that they have the cash, equity and margins that they do. What would have happened if they did not make acquisitions ? Of course in many of them they failed, but overall, the equity has grown a lot based on that. Regarding buybacks: I prefer them than receiving money on dividends and losing 15% or more tax in the process and having to think where to allocate my money or buying the same shares after losing the tax. If they had not done those buybacks the stock maybe would be even lower by now, who knows. If they had not compensated their employees who knows also where the company would be. It’s not that simple to just look at some numbers and draw hard conclusions. I don’t see investing that easy. And I definitely could not care less about the share price. Market price is the last thing I look at, and only for the opportunity it gives me to buy cheap.
I personally think the share is near its limits. I see great qualities in the company and its products and quite a good moat. I also hope for the share NOT to go up for a while because I’m a net buyer and love having time to accumulate. So I am actually quite sad that it went up from around 15.
I’m not saying I am right or that you are wrong by being long or short on Cisco. At the end what matters is making money and enjoying it in the process.
Without faith in your actions I think that you get nowhere investing (or anywhere else in life actually). So if you don’t see the quality and value clearly and focus on just some numbers when you invest you really should stay out of it. Your time would better be invested elsewhere because with that level of doubts even by buying at Cisco at 10 you’ll sell out at the first opportunity for a meager profit.
********** END COMMENTS *********
Cheers!
jrv
